2023-08-01 13:30:00 ET
Summary
- A recent Fed paper argues that real longer-run stock returns in the US stock market may be no higher than 2 percent.
- Further, a very small subset of growth stocks that have supercharged the market this year may be stretched, from a valuation perspective.
- The Vanguard Dividend Appreciation ETF may be a good alternative to the Vanguard Total Stock Market ETF based on these underlying theses.
- VIG offers a higher yield and a different portfolio composition, with a greater focus on large-cap value as opposed to growth stocks.
(This article was co-produced with Hoya Capital Real Estate.)
In my most recent article, which was awarded an Editor's Pick, I reviewed a recent Fed paper that suggested that real longer-run stock returns [for the U.S. stock market] in the future are likely to be no higher than about 2 percent, the rate of GDP growth.
From my careful reading of this fed paper, as well as other research into how family offices are positioning themselves for the next few years, I find myself taking a cautious position at present with respect to my own investments.
I have long been a fan of Vanguard Dividend Appreciation ETF ( VIG ). And so, this lazy Sunday afternoon, I found myself taking another look at this ETF on the Vanguard website. Recently, the underlying index for this fund was reconstituted, with Apple ( AAPL ) and Exxon Mobil ( XOM ) being notable additions, as well as Merck ( MRK ) being re-added after a year's hiatus. For more detail on this, please see this excellent article from my fellow contributor, The Sunday Investor.
Today, however, my focus was on comparing VIG against Vanguard's world-class U.S. total market ETF, Vanguard Total Stock Market ETF ( VTI ). To make a long story short, I came away with the definite viewpoint that, if you agree with the underlying theses presented in the two big-picture articles I linked at the outset of this article, you might consider moving at least some measure of funds out of VTI (or similar ETF) and into VIG.
Let's take a look and see how I came to this view, shall we?
Digging In To VIG's Underlying Index & Selection Criteria
VIG seeks to track the performance of the S&P U.S. Dividend Growers Index . The below graphic from VIG's fact sheet visually depicts some of the main features of this index, with a "style box" in the upper-right-hand corner that helps you discern the investment focus.
Digging in just a little deeper using the methodology document S&P provides for the underlying index, we find this supporting detail:
- Stocks must satisfy a 3-month median daily value traded threshold of US$ 1 million (US$ 500,000 for current constituents).
- Companies must have increased dividends every year for 10 consecutive years.
- The index is reconstituted annually, as of December. However, companies continue to be monitored such that, if a company that passed the dividend growth requirement as of the last business day of December, reduces, omits, or eliminates its dividend before the annual reconstitution, it is ineligible for index inclusion.
One last comment. VIG's prospectus clarifies that:
The Fund uses the replication method of indexing, meaning that the Fund generally holds the same stocks as those in its target index and in approximately the same proportions. (Italics in original text)
Some funds explicitly feature that they use the sampling method , selecting a subset of stocks from the target index that they believe, in total, fairly represent the entire index. In contrast, Vanguard specifically calls out that VIG uses a full replication strategy.
Comparing VIG With VTI
On its advisers website, Vanguard offers a very handy tool for comparing various of its ETFs, and even ETFs from competitors. I used this tool to quickly compare VIG and VTI . In this section, I will share a few of the interesting details I found.
First, a couple of very high-level details. VIG carries an expense ratio of .06%, slightly higher than the .03% charged by VTI. However, this difference is so small as to be inconsequential. The second is that VIG's yield is not dramatically higher than VTI's. As of June 30, 2023, VIG offered an SEC yield of 1.82% vs. VTI's 1.56%. Using a slightly different calculation, distribution yield, VIG is ahead by a slightly larger margin: 1.9118% to 1.5144%.
To be clear, though, I am not recommending you consider moving funds from VTI to VIG because of the difference in yield. On its own, I don't consider this factor as hugely significant.
At this point, it is more about the overall portfolio differences between the two.
First of all, in this tool, Vanguard offers what they refer to as Style Boxes. Basically, these graphically represent the breakdown of the types of equities included in the particular ETF. Here they are for VIG and VTI.
First of all, please focus on the size, or market cap, of the included stocks. In VIG, the Large style boxes add up to some 84% of the fund, vs. 72% for VTI. Clearly, then, large-cap stocks comprise a greater percentage of VIG.
But even further, please notice which specific box is the most prominent in VIG. Within the large-cap segment, it is companies identified as a blend of value and growth, as opposed to the much heavier weighting in pure growth stocks in VTI.
From there, I moved to the Equity Details section of the analysis.
Here, what I focused in on was the defensive characteristics of VIG. In combination, the sectors of Basic Materials, Consumer Defensive, and Health Care comprise some 31.74% of VIG, compared to only 22.15% in VTI. Most of that difference can be found in the Communications Services and Technology sectors, which comprise a mere 24.08% of VIG vs. a substantially higher weighting of 35.51% in VTI.
Let's see how this plays out in the Top 10 holdings of the respective funds.
First, and this came as a pleasant surprise to me, despite VIG only containing 314 holdings vs. a whopping 3,854 in VTI, its Top 10 holdings are not dramatically overweighted compared to VTI, at 31.23% to 25.91%. This speaks to VIG maintaining a healthy level of diversification.
Going a step further, however, please notice the relative weightings of AAPL and Microsoft ( MSFT ). While they are the 2 largest holdings in both ETFs, both their individual and combined weightings are less in VIG than they are in VTI!
Second, once you drop down below these two holdings, the broad diversification of VIG across different sectors begins to really jump out at you.
Why Allocate In Favor Of VIG Now?
I decided to put my last graphic from this exercise in a new section of the article.
In this graphic, Vanguard reveals the competitive performance of the competing ETFs, and also benchmarks this against the S&P 500.
As can easily be seen, VIG has substantially underperformed VTI over the past 3 months and even more so YTD. This is not at all surprising, as a relatively small number of stocks have supercharged the market over recent periods.
As you expand out the time frames, however, it can quickly be seen that this is not the norm. Over 3-, 5-, and 10-year time spans VIG has performed quite admirably.
So here's the deal. If you believe that the performance of the very hottest segments of the market will continue, perhaps you stay with VTI.
On the other hand, if you believe that things have gotten a little ahead of themselves and that Jerome Powell means what he says about maintaining and even increasing restrictive conditions until the Fed is sure it has inflation under control, then I believe you may wish to seriously consider VIG as an alternative.
For further details see:
VIG: Sell Your VTI And Buy This Instead