VSS - VSS: Low-Yielding Diversified Small-Cap Fund Investing In Right Markets

Summary

• Vanguard FTSE All-World ex-US Small-Cap ETF invests in growth and value stocks of small-cap companies in equity markets outside the US, and generates low but decent yield.
• VSS generates a decent overall return over the longer term, and the fund’s returns are also in sync with other small-cap equity funds.
• VSS’s portfolio is well-diversified both in developed and emerging markets, and significantly invests in sectors that have high-growth potentials.
• There is some concern about future price performance of VSS, as small-cap funds may witness slow growth if there is a global recession.

- by Snehasish Chaudhuri, MBA (Finance).

Vanguard International Equity Index Funds - Vanguard FTSE All-World ex-US Small-Cap ETF ( VSS ) is an exchange-traded fund ("ETF") that invests in growth and value stocks of small-cap companies in various equity markets outside the United States. The fund follows benchmark FTSE Gbl SmallCap Ex US TR USD and uses representative sampling techniques to create its portfolio. As the name suggests, both the index and the fund are composed of small-cap stocks. Although the fund invests in small-cap stocks, the total asset under management ("AUM") is quite large at $9.53 billion. The fund generates a low but decent yield and a strong total return over the long run.

Vanguard FTSE All-World ex-US Small-Cap ETF Has a Balanced Portfolio

Vanguard FTSE All-World ex-US Small-Cap ETF is currently trading at $102.48, almost at par with its net asset value ("NAV") of $102.24. The fund has a very low expense ratio of 0.07 percent. A low expense ratio makes diversified investments much easier in small-cap equity funds. It pays quarterly dividends, with an annual average yield between 2 percent and 4 percent. Although the total return has been very poor this year, between the high-growth period between 2017 & 2021, VSS generated an annual average total return of 11.7 percent.

Vanguard FTSE All-World ex-US Small-Cap ETF has a fully diversified portfolio - both sectoral and regional. I generally prefer funds which have a major percentage of AUM invested in four sectors - information & communication technology ((ICT)), financial, industrial, and healthcare - as I believe these sectors have high growth prospects in the coming decade. In the case of VSS, this proportion is almost 54 percent, that is more than half of the entire portfolio of investments.

This Vanguard Group, Inc. managed fund invests in public equity markets of the global ex-U.S. region and has a portfolio of more than 4200 equity stocks. For obvious reasons, a very small proportion of the entire fund is invested in a particular stock. Its top 25 investments comprise less than 7 percent of the entire portfolio. Two-thirds of its assets are invested in four developed markets spread throughout the globe, as well as four best emerging markets globally. While the economies of India, China, Taiwan, and South Korea are poised for high growth, markets in Canada, United Kingdom, Japan, and Australia are some of the most stable and credible markets. In a nutshell, this fund has invested in the right markets, maintaining a balance between risk and returns.

Risks Associated with Vanguard FTSE All-World ex-US Small-Cap ETF

All the small-cap equity funds have performed more or less the same way. Post-pandemic, all these funds made a steady recovery and reached their peaks during July 2021, and from the beginning of this year, started falling. At present, most of these funds are trading somewhere near their pre-pandemic levels. Small-cap stocks generally are traded less than the large-cap and mid-cap stocks. At the same time, there are higher chances of these stocks not generating significant returns over an extended period of time. Going forward, I believe that Vanguard FTSE All-World ex-US Small-Cap ETF will continue to generate a low but decent yield and almost equal percentage of price growth over a long period of time.

The major markets in which Vanguard FTSE All-World ex-US Small-Cap ETF has invested consist of emerging markets like India, China, Taiwan, and South Korea, as well as developed markets like those in Canada, the United Kingdom, Japan, and Australia. All these countries have investment-grade sovereign ratings. However, the economies of Japan, Canada, and the United Kingdom are slowing down. China and Taiwan are involved in a political conflict, which enhances the risk of investing in such areas. The recent surge in Covid-19 in China is going to be detrimental for its economy. All these factors need to be kept in mind before investing in this fund, as the kind of return the fund is generating now may become doubtful in case a recession takes place globally.

Investability of VSS according to My "7 Factor Model for Evaluating Global Funds"

I find Vanguard FTSE All-World ex-US Small-Cap ETF to be attractive according to my "7 Factor Model for Evaluating Global Funds." It qualifies for the minimum requirements with respect to AUM, stock price, and has a decent overall return over the longer term. During the 5-year period between 2017 and 2021, the annual average total return was more than 11 percent. The current year's return has been negative, but this is the case with all funds and broader markets. VSS's returns are also in sync with other small-cap equity funds. It has a very low expense ratio, which enables investors to benefit from a highly-diversified portfolio.

The portfolio is well-diversified both in developed and emerging markets, and carries a low level of risk. It invests the majority of its assets in four sectors (ICT, financial, technology, and industrial) that have high-growth potential. This makes the current level of yield sustainable. However, there is some concern about the future price performance of this fund, as small-cap funds may not witness any growth if there is a global recession.

In the absence of any price growth, the VSS yield will not be lucrative enough. The fund is also currently trading at par with its NAV. Thus, at present, I would suggest a hold rather than a buy for investors of Vanguard FTSE All-World ex-US Small-Cap ETF.

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