2023-04-20 16:39:53 ET
Summary
- VTV needs little introduction. It's Vanguard's leading large-cap value ETF with over $100 billion in assets under management and an ultra-low 0.04% expense ratio.
- VTV has struggled this year, lagging behind VOOV by 6%. However, 5 stocks are largely responsible: Meta Platforms, Microsoft, Amazon, salesforce.com, and Pfizer.
- VOOV has kept up with the market due to favorable exposures to growth stocks. However, the January 2023 rally linked to massive layoffs is likely a short-term win only.
- Plenty of risks exist heading into Q2 earnings season, but VTV's set up well barring any extraordinary surprises. With the same growth, VTV's valuation is five points less than VOOV.
- The recent underperformance is disappointing, but I see no reason to abandon VTV now. Stay the course, and I'm confident it will bounce back.
Investment Thesis
The Vanguard Value ETF (VTV) has struggled this year. Through Q1 2023, VTV declined by 1% while other low-cost peers like the Vanguard S&P 500 Value ETF (VOOV) gained 5%. VTV's long-term track record remains admirable. Still, investors should focus on the fund's current stocks to avoid chasing returns because that determines future returns.
This article aims to identify what's gone wrong with VTV this year. I will perform a straightforward performance attribution analysis using VOOV as a benchmark to identify reasons for performance differences by sector. After we understand these reasons, I will examine if there's a likelihood the issues will persist. Ultimately, I still recommend VTV, and I hope this analysis helps settle the nerves of some shareholders.
VTV Overview
VTV tracks the CRSP US Large Cap Value Index, selecting large-cap stocks based on the following five factors:
- Book To Price Ratio
- Future Earnings To Price Ratio
- Historical Earnings To Price Ratio
- Dividend To Price Ratio
- Sales To Price Ratio
The Index is free-float market-cap-weighted but has some overlap with the CRSP US Large Cap Growth Index. The Index also uses some buffer rules to prevent turnover, so VTV isn't a "pure" value ETF. Instead, it is a low-cost choice for broad-market investors with a value lean. It's also an easy way to avoid many mega-cap growth stocks that might be at risk in a recession.
VTV's top ten holdings total 22% and include familiar names like Berkshire Hathaway ( BRK.B ), Exxon Mobil ( XOM ), and UnitedHealth Group ( UNH ). It may seem concentrated, but it's highly well-diversified for a value ETF. There are 336 total holdings across 109 GICS industries, with no industry accounting for more than 6%. Pharmaceuticals (5.58%), Diversified Banks (5.18%), and Integrated Oil & Gas (4.61%) are the most significant three.
Sector exposures for the SPDR S&P 500 ETF ( SPY ), VOOV, and VTV, are listed below. This table illustrates the substantial changes S&P 500 Style Indices had at its annual rebalancing in December. In this article on SPYV , an alternative to VOOV, I noted how Microsoft ( MSFT ) and Amazon ( AMZN ) joined the Value Index as Exxon Mobil and Chevron ( CVX ) moved to the Growth Index.
The table reflects these Index changes. Compared with VTV, VOOV overweights Technology by 9% and underweights Energy by 6%. The performance of the four stocks helps explain why VTV has underperformed VOOV by 4.54% YTD.
VTV Analysis
Performance Attribution
Analysts can do a performance attribution analysis to reveal why a particular portfolio underperformed a benchmark. By sector, we can calculate an:
- Allocation effect: measures the portion of excess return attributable to overweighting the better-performing industries
- Selection effect: measures the portion of excess return attributable to selecting the better-performing stocks within each industry
A negative allocation effect indicates the portfolio's allocation by sector was a performance detractor. A negative selection effect means the portfolio's stock-picking abilities were poor, as stocks in the same sector outperformed. The table below summarizes the results for VTV as the test portfolio and VOOV as the benchmark. Please note that these results are for price returns only, and the weights used are estimated using current and historical sector exposures from January 2023.
This analysis reveals that approximately half of the total negative attribution is related to merely underweighting Communication Services, Consumer Discretionary, and Technology stocks. Not coincidentally, these are growth-oriented sectors that have all outperformed SPY YTD.
A simple way to view the VTV's total allocation effect is if it had the same sector exposures as VOOV, performance would improve by 3.50%. As for the -3.03% selection effect, most is related to Health Care stocks. It's a surprising find, and I narrowed it down to four names that VTV overweights by 7%: UnitedHealth Group, AbbVie ( ABBV ), Johnson & Johnson ( JNJ ), and Pfizer ( PFE ). All are down on the year, with Pfizer a considerable drag.
Why VTV Underperformed: Look To These 5 Stocks
Earlier, I highlighted how XLC , XLY , and XLK outperformed the market this year. Interestingly, only a handful of stocks are key contributors, delivering nearly all the excess gain in January. Consider that Invesco's equal-weight versions of these sectors have underperformed by 12.74%, 7.00%, and 10.53%, respectively.
Surprisingly, five stocks explain 60% of the underperformance, so it's simple to explain. VTV underweights Meta Platforms ( META ), Microsoft, Amazon, and salesforce.com ( CRM ) by 11.35% and overweights Pfizer by 1.38%. The critical question is if these stocks will continue on their current paths. Seeking Alpha has a "Strong Buy" rating on Meta Platforms and salesforce.com, supported by excellent "A-" Earnings Revision Grades. Therefore, continued outperformance is undoubtedly possible.
Still, the four underweighted stocks have one thing in common: massive layoffs. According to this tweet from The Kobeissi Letter, Amazon, Meta Platforms, Microsoft, and salesforce.com have let go of 66,000 workers since November 2022. Mark Zuckerberg previously referred to 2023 as a "Year of Efficiency," estimating $3-$5 billion in restructuring cost savings.
It's a winning strategy, at least in the short-term, as all are up on the year. However, these companies continue to struggle each earnings season. Meta Platforms has missed consensus earnings estimates in the last three quarters. Microsoft met consensus the previous four quarters even as analysts downgraded expectations. Finally, Amazon Web Services' growth rates are slowing, potentially setting up a valuation contraction when the company reports earnings next week. There remains plenty of risk with these high-growth companies that, fortunately, VTV avoids. We could see VTV close the gap with VOOV over the next few weeks, especially with another disappointing earnings season.
Besides, VTV's overall fundamentals are still solid. The following table highlights selected metrics for VTV's top 25 industries, with summary metrics for VTV and VOOV in the final rows. VTV has a lower five-year beta (0.90 vs. 1.01) and a higher gross dividend yield (2.53% vs. 1.98%), with similar growth, profitability, and EPS revision scores.
The difference is valuation. VTV trades at 17.44x forward earnings and 14.48x trailing cash flow, about five points cheaper than VOOV. Simply put, VTV does a better job capturing the value factor, and if you have doubts about how long the tech rally will last with a possible recession approaching, it's superior.
Investment Recommendation
VTV has underperformed VOOV YTD primarily due to growth stocks in the Communication Services, Consumer Discretionary, and Technology sectors. The S&P 500 Value Index, which VOOV tracks, reconstituted at a good time just before growth stocks took off in January. Returns afterward weren't as impressive, indicating that the massive cost-cuts are baked into the stock price and little, if any, upside, remains. Instead, I recommend VTV shareholders hold on. The fund offers the same estimated sales and earnings growth as VOOV but trades at a five-point discount on earnings and cash flow. Quality remains high and avoids much risk heading into the Q2 earnings season. Thank you for reading, and I look forward to the discussion in the comments section below.
For further details see:
VTV: These 5 Stocks Explain Its Disappointing Start To The Year