VONG - VBK: A Big Issue Being Small

2023-10-20 17:30:50 ET

Summary

• Vanguard Small-Cap Growth Index Fund ETF Shares has underperformed large-cap growth stocks in the U.S. equity market over the long term.
• The VBK fund's low expense ratio of 0.07% is advantageous for investors seeking cost-effective exposure to small-cap growth stocks.
• The current market cycle has not favored small-cap stocks, making VBK a less attractive option for buy and hold investors.

Pain is weakness leaving the body. - Chesty Puller.

There is no new bull market in small caps. Never was. And that dynamic looks set to continue, which is why for buy and hold investors, the Vanguard Small-Cap Growth Index Fund ETF Shares ( VBK ) is one I would rather avoid for now. This exchange-traded fund ("ETF") aims to provide investors with exposure to small-cap growth stocks in the U.S. equity market. VBK follows a passively managed, full-replication strategy to track the performance of the CRSP US Small Cap Growth Index. The fund focuses on small-cap growth equity and remains fully invested. Its low expenses help minimize net tracking error, which is an advantage for investors seeking cost-effective exposure to this asset class.

Benchmark and Performance History

The CRSP US Small Cap Growth Index serves as the benchmark for VBK. This index accurately represents the small-cap growth segment of the U.S. equity market while delivering low turnover. The problem has been the cycle being brutal for all things small. When we look at the price ratio of VBK relative to the S&P 500 (SP500), we can see that this fund has lagged for a decade. The harsh reality of the world we've been in is that anything outside of large-caps has been a disappointment.

That's not to say this isn't a good fund for what it does. VBK boasts a low expense ratio of 0.07%, which is significantly lower than the average expense ratio for small-cap growth funds. This cost efficiency is advantageous for investors as it helps maximize their returns. This has been more of a cycle issue than a fund-specific or expense issue where asset allocation just hasn't favored this part of the marketplace.

Holdings and Diversification

Vanguard Small-Cap Growth Index Fund ETF Shares holds a diverse portfolio of small-cap growth stocks, with 645 stocks in its holdings. The median market cap of the stocks is $6.3 billion. The fund's top ten holdings include companies such as Targa Resources Corp., PTC Inc., Axon and Entegris Inc. These holdings represent a small portion of the fund's total net assets and provide investors with exposure to various sectors, including technology, industrials, healthcare, and consumer discretionary.

Peer Comparison and Investment Considerations

When comparing VBK to its peers, such as Vanguard Russell 1000 Growth ETF ( VONG ) and Vanguard S&P 500 Growth ETF ( VOOG ), it becomes evident that large-cap growth stocks have offered better returns and downside protection. Large-cap growth stocks tend to have stronger moats, generate robust cash flows, and possess the financial strength to weather economic downturns. So this really isn't a style issue but more so a cap one. I don't favor growth stylistically here anyway, and the reality is that many small-cap companies do have significant debt which could be problematic, as that debt gets rolled over into higher rates.

Conclusion

The Vanguard Small-Cap Growth ETF provides investors with exposure to small-cap growth stocks in the US equity market. While VBK has delivered impressive returns since its inception, it has underperformed its large-cap growth peers over the long term. The momentum is not here for this, and while there might be tactical moments in time to position here, it's not one to consider until there's a clearer cycle change favoring small-caps and a continuation of growth momentum.

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