VIG - VIG: Dividend Growth And Compounding For Long-Term Investors

2023-06-20 12:45:39 ET

Summary

• The Vanguard Dividend Appreciation Index Fund is a low-cost, transparent ETF that invests in consistent dividend-paying and growing U.S. stocks, providing exposure to high-quality holdings.
• Since its inception in 2006, VIG's dividend has grown at a compounded annual growth rate of over 12%, and the fund has demonstrated lower volatility and risk compared to the broader equity market.
• VIG can be used as a core U.S. equity holding for long-term investors, offering resilience and consistent returns through various market cycles and economic conditions.

My investment philosophy is built around several principles, including: My investments need to be liquid, low-cost, and transparent; diversification mitigates risks and creates the opportunity for long-term compounded returns; patience is one of the few advantages remaining for individual investors and should be leveraged as much as possible.

To effectively put these principles and others into practice requires finding investments that align with these core beliefs while also providing exposure to high quality holdings.

An ETF that accomplishes the above, plus so much more, is the Vanguard Dividend Appreciation Index Fund ( VIG ). I have been familiar with this fund for many years as I have used it as a core position within client portfolios. While some of those ultra-high net worth individuals would bristle at the simplicity of the holding, believing they were missing out on more “sophisticated” investments, its undeniable quality superseded those concerns.

Portfolio Characteristics

VIG invests in a portfolio of U.S. stocks that are consistent dividend payers and growers, mostly large cap. The current yield is just under 2% and the expense ratio is 0.06%. The fund exhibits an even balance between growth and value names spread across all S&P sectors except for real estate. The portfolio currently holds more than 300 positions with the top 10 representing about 32% of fund value. The focus on quality means most of the holdings are well positioned for a range of economic outcomes.

In the event of a recession, for example, there is a significant exposure to defensive sectors like consumer staples and healthcare, although the allocation to utilities is comparable to the broader equity market. Many of the holdings boast some form of an economic moat, a competitive advantage that allows them to maintain and grow revenue through various stages of the business cycle while preserving or increasing margins. If AI turns out to be everything the advocates hope for, and the economy booms, then there is exposure to large cap tech and consumer discretionary as well. Regardless of the future path of the economy, the holdings have exhibited an ability to perform while growing the dividends paid to shareholders.

Dividend Growth

Since its 2006 inception, the dividend paid by VIG has grown by a compounded annual growth rate of over 12%, using quarterly dividends for the calculation. That pace has risen slightly over the last 3 years after dropping to 7-10% during the 2010s. Many of the top holdings represent the who’s-who of the dividend aristocrats: Exxon Mobil ( XOM ), Johnson & Johnson ( JNJ ), JPMorgan Chase & Co ( JPM ), Proctor & Gamble ( PG ), and many more. Although the largest position, Microsoft ( MSFT ), isn’t considered a dividend aristocrat, it has grown its dividend at a compounded rate of nearly 12% for the past 10+ years.

Recent Performance

As this is a low-cost and passively managed strategy, it has performed in line with expectations. That is, it has trailed the S&P 500 on total return basis over the last year, largely due to the S&P 500’s greater tilt toward mega cap tech names that have rallied so far this year.

VIG has also underperformed the S&P 500 on a total return basis for longer periods, but by a small margin. This is made up for in part by the lower volatility of returns experienced by VIG shareholders. Compared to other large cap blend funds, the fund has generated above average total returns with below average risk (i.e. standard deviation of returns).

Risk-Adjusted Returns

The fund has also demonstrated its ability to hold up well and reduce volatility during declining or choppy markets. From the 2021 market peak to today, VIG has outperformed SPY on a total return basis, but even more so on a risk-adjusted basis.

Using data from the last 5 years, the VIG has a beta of 0.86 with respect to the S&P 500 TR. Over that period, VIG has captured 87% of the upside of the S&P, but only 84% of the downside.

Portfolio Positions

The focus on quality and businesses with wide economic moats and growing dividends means that some of the recent high-flying stocks have been excluded from the portfolio. Names like Tesla ( TSLA ) and NVIDIA ( NVDA ) are excluded as they don’t meet the dividend criteria. Although NVIDIA pays a small dividend, the length of that history, the amount of the dividend and its zero growth in recent years disqualify it from being a VIG holding. Position sizes are more even across the portfolio, reducing the impact of names like Apple ( AAPL ) and Microsoft on performance, another factor that has contributed to recent underperformance. To put a finer point on that, in the SPDR S&P 500 ETF Trust ( SPY ), Apple is the largest position at 7.45% followed by Microsoft at 6.98%. In VIG, Microsoft is the largest position at 5.13% followed by Apple at 4.60%.

Risks

Although there are always idiosyncratic risks embedded into individual holdings, these are effectively diversified away through the inclusion of over 300 positions in the fund. The focus on quality dividend payers and avoidance of any meaningful concentration in any one stock also help prevent unnecessary risks.

Risk as measured by volatility or standard deviation of returns is lower than that experienced by the broader equity market. This muted volatility can be attributed to the stability of the businesses in the portfolio, as well as the commitment to returning value to shareholders through cash dividends. Most of the businesses in the portfolio exhibit lower risk than the broader market or broader economy due to the prevalence and strength of their individual competitive advantages.

Core U.S. Equity Position

VIG can be used as a core U.S. equity holding. Due to the tilt toward larger companies, it might make sense for some investors to add dedicated exposure to mid-cap and small-cap in accordance with target allocations. That said, there is some exposure to those smaller companies as well as value/growth and 10 of 11 sectors.

Final Thoughts

A position in VIG offers investors exposure to high quality businesses each with a track record of paying and growing their dividends. This ETF checks all the boxes within my investment philosophy, which is ultimately geared toward compounding returns over years and decades, not days, weeks, or months. The holdings in this portfolio have proven their resilience, enduring market cycles as well as the unique economic circumstances of the last few years. No matter what the future holds, no matter how monetary or fiscal policy evolves, or what the fast money chases, VIG will remain a consistent and dependable holding for long-term investors who want to generate wealth. As mentioned above, I believe that VIG is suitable to represent a significant portion of investors’ U.S. equity allocations, but strongly advise that all potential investors consider it within the broader context of their strategic asset allocation as well as personal needs and constraints. Any overweight or underweight positions need to be considered carefully to understand the impact on long-term total returns. Thank you for reading. I look forward to seeing your feedback and comments below.

For further details see: