XOM - MGV ETF: Attractive Valuation Average Performance

2023-05-25 18:20:47 ET

Summary

• Vanguard Mega Cap Value Index Fund ETF Shares selects large-cap stocks using five metrics.
• The heaviest sectors are healthcare and financials.
• Valuation ratios and fees are attractive.
• However, it has lagged the benchmark and at least two competitors since inception.
• Two weaknesses of value indexes.

This article series aims at evaluating exchange-traded funds (ETF) regarding the relative past performance of their strategies and metrics of their current portfolios. As holdings change over time, updated reviews are posted from time to time.

MGV Strategy And Portfolio

Vanguard Mega Cap Value Index Fund ETF Shares ( MGV ) started investing operations on 12/17/2007 and is tracking the CRSP US Mega Cap Value Index. It has a portfolio of 143 stocks, a dividend yield of 2.59% and a cheap expense ratio of 0.07%. Distributions are paid quarterly.

As described on the CRSP website ,

CRSP classifies value securities using the following factors: book to price, forward earnings to price, historic earnings to price, dividend-to-price ratio and sales-to-price ratio .

The fund has a low turnover rate: 8% for the most recent fiscal year. It invests almost exclusively in U.S. companies (99.4% of asset value). The heaviest sectors are healthcare (21.1%), financials (19%), industrials (14.2%) and consumer staples (12.2%). Other sectors are below 10% individually and 34% in aggregate. Compared to the S&P 500 (SP500), MGV overweights the top four sectors listed above, plus energy and utilities. It underweights mostly technology, consumer discretionary and communication services.

As expected, MGV is cheaper than the S&P 500 regarding the usual valuation ratios, as reported in the next table.

The top 10 holdings, listed below with valuation metrics, represent 27.2% of asset value. They are all below 4%, so risks related to individual companies are moderate.

Performance

The next chart compares the total returns of MGV, SPDR® S&P 500 ETF Trust (SPY), and three large-cap value ETFs:

• iShares S&P 500 Value ETF ( IVE )
• First Trust Large Cap Value AlphaDEX Fund ( FTA )
• Invesco Dynamic Large Cap Value ETF ( PWV )

MGV beats IVE and lags the other funds in the list. In the last 12 months, it is in the middle of the pack, and close to flat:

Comparing MGV With My Dashboard List model

The Dashboard List is a list of 80 stocks in the S&P 1500 index, updated every month based on a simple quantitative methodology. All stocks in the Dashboard List are cheaper than their respective industry median in Price/Earnings, Price/Sales and Price/Free Cash Flow. After this filter, the 10 companies with the highest Return on Equity in every sector are kept in the list. Some sectors are grouped together: energy with materials, communication with technology. Real estate is excluded because these valuation metrics don't work well in this sector. I have been updating the Dashboard List every month on Seeking Alpha since December 2015, first in free-access articles, then in Quantitative Risk & Value.

The next table compares MGV performance since 1/1/2008 with the Dashboard List model, with a tweak: here the Dashboard List is rebalanced annually to make it comparable with a passive index.

Past performance is not a guarantee of future returns. Data Source: Portfolio123.

The Dashboard List beats MGV by 2.7% in annualized return. However, ETF metrics are real, and the model is simulated.

Methodological Weaknesses

Like most value funds, Vanguard Mega Cap Value Index Fund ETF Shares ranks all stocks on the same criteria. It means the valuation ratios are considered comparable across sectors and industries. Obviously, they are not: my monthly dashboard here shows how valuation and quality metrics may vary across sectors. A consequence is to privilege sectors where valuation ratios are naturally cheaper, especially financials.

The second weakness comes from the book-to-price ratio, which adds some risk in the strategy. Historical data show that a large group of companies with low price/book has a higher probability to hold value traps than a same-size group with low price/earnings, price/sales or price/free cash flow. Statistically, such a group will also have a higher volatility and deeper drawdowns in price. The next table shows the return and risk metrics of the cheapest quarter of the S&P 500 (i.e., 125 stocks) measured in price/book, price/earnings, price/sales and price/free cash flow. The sets are reconstituted annually between 1/1/2000 and 1/1/2023 with elements in equal weight.

Data calculated with Portfolio123.

This explains why I use P/FCF and not P/B in the Dashboard List model.

Takeaway

Vanguard Mega Cap Value Index Fund ETF Shares selects large-cap companies using a ranking system based on five valuation metrics. It is cheaper than the large-cap benchmark SPY in valuation, and also in expense ratio. However, it has lagged SPY and at least two competitors since inception. Most value ETFs have two methodological weaknesses, and Vanguard Mega Cap Value Index Fund ETF Shares is not an exception: stocks are ranked regardless of their industries, and the book-to-price ratio is a factor increasing volatility.

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