Summary
- VIOG invests in U.S. small-cap growth stocks in the S&P 600 Index.
- The fund’s total return was inferior to its large-cap growth peer.
- VIOG may rebound earlier than its small-cap value peer when this bear market ends but uncertainty is high in the near term.
ETF Overview
Vanguard S&P Small-Cap 600 Growth ETF ( VIOG ) owns a portfolio of U.S. small-cap growth stocks. The fund basically includes growth stocks in the S&P 600 Index. Although VIOG delivered superior total return of 340.6% since its inception in September 2010, it still trailed its large-cap growth peers by a wide margin. Since VIOG has declined a lot more than its small-cap value peer, we think VIOG may be set up for a meaningful rebound when this bear market ends. However, there is still tremendous uncertainty, as the rate will likely go higher and stay elevated for a lengthy period due to persistent inflation. Hence, the risk and reward profile is not attractive. We recommend investors to stay on the sidelines.
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Fund Analysis
A challenging year for VIOG
VIOG had a challenging year in 2022 due to the Federal Reserve tightening its monetary policy. As a result, the fund delivered a total return of negative 16.39%. This was much worse than the total return of negative 9.52% that its peer Vanguard S&P Small-Cap 600 ETF ( VIOO ) delivered. On the other hand, its value counterpart, Vanguard S&P Small-Cap 600 Value ETF ( VIOV ), which owns a portfolio of value stocks in the S&P 600 index, has lost only 2.41%.
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Looking forward, we have a few observations that will inform investors when making their decision to invest in VIOG especially if this is going to be a long-term investment:
1. Small-cap growth stocks may outperform its small-cap value peers, but not by a lot.
Small-cap growth stocks tend to outperform value stocks. This is generally true and especially evident in large-cap stocks. For example, since 2010, value stocks in the S&P 500 index delivered a total return of 340.6%. On the other hand, growth stocks in the S&P 500 index outperformed with a total return of 405.7%. The difference was more than 65 percentage points.
However, when we compare growth stocks and value stocks in the S&P Small-Cap 600 index, the difference was quite minor. Although growth stocks still outperformed value stocks, the margin is not as wide. As can be seen from the chart below, VIOG’s total return of 313% only outperformed its peer, Vanguard S&P Small-Cap 600 Value ETF ( VIOV ), by 35 percentage points.
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This smaller difference between small-cap growth and value ETFs than its large-cap peers is likely because many small-cap growth stocks are not as established as large-cap growth stocks. Some of these small-cap growth stocks may even be start-ups that are still not profitable and hence may face stronger headwinds in an economic downturn than its small-cap value peers. On the other hand, large-cap growth stocks tend to generate excessive cash flows and therefore are much better positioned in times of turmoil.
2. Large-cap growth stocks are generally better than small-cap growth stocks.
As we have discussed in our previous point, we like large-cap growth stocks as large-cap growth stocks generally generate a lot of cash flows and has the capability to continue to return cash to its shareholders through share buybacks or dividend distributions even in an economic downturn. On the other hand, many small-cap growth stocks do not generate excessive cash flows or are still unprofitable. Hence, they tend to underperform their large-cap growth peers in the long run. Therefore, we favor large-cap growth ETFs such as VOOG than VIOG.
3. VIOG should rebound first than its value peer.
Since growth stocks tend to trade at lofty valuations in a bull market, they can be quite vulnerable in a bear market as well. This was evident in 2022 where VIOG underperformed VIOV by a wide margin. However, when the market rebounds, especially in a new bull market, we think growth stocks will rebound first. As we can see from the chart below, VIOG and VIOV tend to go in parallel with each other, declining together and rebounding together with similar timing. However, VIOG dropped a lot more than VIOV in this bear market that we are in right now and have trailed VIOV in the recent rally. Therefore, we think VIOG will eventually return to investors’ favor especially when the bear market turns to a bull market.
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Should you be buyers of VIOG now?
If you are a long-term investor, we do not think VIOG is a good choice for you. You will be better off buying large-cap growth ETFs than VIOG as they provide better long-term returns. In addition, large-cap growth ETFs comes with less risks as large-cap growth stocks tend to be more established and generate excessive cash flows than small-cap growth stocks. However, if you are an investor with a shorter investment horizon, VIOG may provide better returns than their value peers, especially if you believe this bear market will soon end. However, this is very uncertain as inflation has proven to be very persistent so far. Therefore, the Federal Reserve will likely continue to raise rates in the upcoming few meetings, albeit at a slower pace.
Investor Takeaway
We do not like VIOG as it provides inferior total returns in the long run than its large-cap growth peer. Although VIOG has better near-term potential than its value peer, we think there is still tremendous uncertainty due to unpleasant inflation data we have seen in the past few weeks. Therefore, when considering its risk and reward profile, we do not see VIOG as attractive. Investors should seek opportunities elsewhere.
Additional Disclosure : This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.
For further details see:
VIOG: Its Large-Cap Growth Peer Would Be A Better Choice