ADSK - VFQY: Valuation And Diversification Look Great Return Not So Much

2023-09-11 00:40:15 ET

Summary

• Vanguard U.S. Quality Factor ETF is an actively-managed fund that invests in U.S. stocks with strong fundamentals.
• VFQY is more diversified than its competitors in terms of holdings, sectors, and size segments.
• The fund is cheaper than its competitors in terms of valuation metrics, but its past performance has been underwhelming.

This article series aims at evaluating ETFs regarding the relative past performance of their strategies and quality of their current portfolios. As holdings and data change over time, updated reviews are posted when necessary.

VFQY strategy and portfolio

Vanguard U.S. Quality Factor ETF (VFQY) started operations on 02/13/2018 with the objective of investing in stocks with strong fundamentals. It is an actively-managed fund with 448 holdings, a 12-month distribution yield of 1.55% and an expense ratio of 0.13%. Dividends are paid quarterly.

As described by Vanguard , portfolio managers select stocks using...

a rules-based screen designed to promote diversification and to mitigate exposure to certain less liquid stocks. Securities with relatively strong fundamentals may be identified by measures such as strong profitability, sustainable earnings, and healthy balance sheets.

The fund is actively managed: It allows a lot of flexibility in the investing process, but it is impossible to backtest or duplicate like an index-based fund.

VFQY is almost exclusively invested in the U.S., from micro to mega cap companies.

VFQY has three major competitors tracking rules-based indexes:

• iShares MSCI USA Quality Factor ETF (QUAL)
• JPMorgan U.S. Quality Factor ETF (JQUA)
• Invesco S&P 500 Quality ETF (SPHQ)

This list doesn't include funds with hybrid strategies where quality is combined with other investing styles, like momentum or dividend (JOET, QDF, DGRW,…).

These funds have similar expense ratios. VFQY is the most recent, the smaller in assets and the less liquid one. Its portfolio is better diversified regarding component number and weight in the top 10 holdings, as reported in the next table.

Data source: Seeking Alpha

The portfolio is nicely balanced in its top three sectors - consumer discretionary, technology and industrials - each of them weighs between 18.7% and 19.7% of asset value. They are followed by financials, energy and healthcare, in a 9% to 13% range. Other sectors are below 6%. Compared to its competitors, VFQY overweights mostly consumer discretionary and industrials. It underweights technology, healthcare, communication and almost ignores real estate and utilities.

The next table lists the top 10 holdings with fundamental ratios. The heaviest one weighs about 2%, so risks related to individual companies are low.

Data: Portfolio123

Fundamentals

The next table compares fundamental metrics in the four quality ETFs, and adds the S&P 500 as a benchmark (SPY).

Source: Fidelity

VFQY is much cheaper than the benchmark and its competitors regarding valuation ratios. It is in the middle of the pack for growth metrics, yet better than SPY.

Performance

The next chart plots total returns since the fund's inception.

VFQY has lagged the benchmark and its competitors by 17% to 26% since February 2018, and by 5% to 10% in 2023 to date (next chart). However, price history is short and may not be indicative of future performance.

In previous articles, I have shown how three factors may help cut the risk in a portfolio: Return on Assets , Piotroski F-score , and Altman Z-score . The next table compares VFQY since 3/1/1018 with a subset of the S&P 500: stocks with an above-average ROA, a good Altman Z-score and a good Piotroski F-score. The subset is rebalanced annually to make it comparable with a passive index.

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

VFQY underperforms this quality subset based on very simple rules. However, ETF performance is real, and this subset is hypothetical. My core portfolio holds 14 stocks selected in this subset (more info at the end of this post).

Quality funds are not focused on dividend, but it is interesting to look at the influence of different quality strategies on distributions and their growth.

All yields are close to the benchmark. Regarding dividend growth, VFQY is second to SPHQ. The 3-year growth rate of 29.3% beats the cumulative inflation: about 15% in the same time, based on CPI.

Takeaway

Vanguard U.S. Quality Factor ETF is an actively-managed fund invested in over 400 U.S. companies with quality characteristics. The fund is more diversified than its competitors across holdings, sectors and size segments. It is also cheaper regarding valuation metrics. However, past performance is underwhelming. Nevertheless, the fund has less than 6 years of historical data, which may be too short to assess the strategy. The next table is a summary of positive and negative points, relative to its peers and the benchmark. Negative points outnumber positive ones, but they may not be of equal importance depending on your situation and objectives. Feel free to use this to make your own score.

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