2023-06-11 23:04:16 ET
Summary
- Vanguard Growth ETF offers a reasonable investment option in the second half of the year, with large-cap US holdings that are cash-rich, including major tech companies.
- Despite concerns of concentration risk, the momentum in the tech sector and the growing interest in AI could drive further gains for VUG in the short term.
- VUG's growing distribution and the cash reserves of its top holdings provide some comfort for investors in a difficult macro-environment.
Main Thesis & Background
The purpose of this article is to evaluate the Vanguard Growth ETF ( VUG ) - and the growth theme more broadly - as an investment option given the macro-climate. While "growth" can often be interchangeable with risk, that really hasn't been the case in the large-cap U.S. space for years now. For example VUG holds top U.S. Tech companies - perhaps "risky" in years past, but today they are mature, well-capitalized companies that have out-performed for a long time. This contrasts with "growth" in other corners of the world or in small caps, for example.
To illustrate this point, let us consider VUG's performance over the past year. It has been a story of ups and downs, of course, but broadly it has risen higher:
Fund Performance (Seeking Alpha)
As you can see, VUG has done extremely well over the past year (I wrote that article in June 2022). This leads me to question if more gains are at all possible given the many conflicting economic signals we face today.
In fairness, I wouldn't recommend anyone get too aggressive on any particular theme or fund right now. We have had some good fortunes since Q4 last year and I wouldn't want to put all those gains at risk. But I do see continued value in large-cap U.S. holdings that are cash rich. This actually includes major Tech companies - which is something of a trend over the past few decades that has reshaped how investors view the market. In this light, I believe funds like VUG that focus on "growth" could be a reasonable play in the second half of the year and I will touch on why below.
Growth Fund's Mostly Track The NASDAQ
First, let us take a look at what "growth" investing really means. For U.S.-oriented funds, this means a big play on Tech. While VUG is more diversified than that, it is still heavily exposed to the Tech sector and is actually a practical way to play the NASDAQ. When we compare the charts of both VUG and the NASDAQ this should be quite clear:
1-Year Performance (Google Finance)
I bring this up not to suggest it is good or bad. Rather, I want investors to simply know what they are buying when they invest in VUG. This could change in the future but not in the near-term. Therefore, one should be aware of this and know what they are getting in to. The concern I would have is primarily concentration risk. For example, I own the Invesco QQQ ( QQQ ), so that is my play on the NASDAQ and/or growth. It may seem like a diversification play to own VUG but, as the graphic above shows, that wouldn't really be the case.
The good news is that the NASDAQ has been a big momentum play for the time being and that sets it up nicely (and VUG by extension) in the short-term. While U.S. equities are up overall in 2023, the out-performance is dramatic:
Index Performance (Bloomberg)
Readers could look at this in two ways. One, it is time to rotate out of Tech and take these profits because this type of out-performance can't keep up. That is a fair argument and I would not fault anyone for getting more prudent at this juncture.
However, way number two is to figure that this momentum will drive more gains in the short-term. This is the camp I am in. But I again emphasize that getting too aggressive after a gain of over 20% is not generally the best move. Stay patient, add on drops/weakness, and keep your portfolio as balanced as you can while enjoying what I expect to be more gains in the coming months for funds like VUG.
These Companies Have Cash
One of the most comforting aspects of investing in large-cap U.S. companies in a difficult macro-environment is their cash reserves. But not all companies - even large-caps - are alike in this regard. In fact, cash balances have been shrinking in the past few years across the S&P 500. This is due to rising input costs, higher wages, and a drawdown on Covid-related stimulus and bond issuance from 2020. This puts many companies more "at risk" of challenges during a recession than they might have been a year ago:
Corporate Cash Balances (Fitch Ratings)
This is concerning if we see a more prolonged or severe recession than anticipated. Of course, that might not happen, but it makes sense to take proactive measures to protect your portfolio against the worst if it does.
With that in mind, the top holdings of VUG put my mind at ease to a degree. These are some of the most well-known companies in the Tech space and dominate the fund:
VUG's Top Holdings (Vanguard)
The good news here is these companies are also cash-rich. Much more so than the average S&P 500 firm. These names collectively control a substantial amount of cash and other short-term assets (known as cash equivalents):
Collective Cash Balances (Barrons)
My takeaway from this is that even those "Tech" can sound risky or the broader growth arena may seem ripe for a pullback, this could actually be interpreted as one of the more safer ideas heading forward. While perhaps counter-intuitive, it is hard to argue with cash. When times get tough, cash is king, and VUG's top holdings certainly have plenty of it.
Other Corners In The World Already Slowing
My next point looks at relative macro-signals. While we in the U.S. have been debating when a recession will happen and how severe it will be, growth keeps on chugging along. By contrast, many other nations are grappling with a more difficult economic backdrop. This means large U.S. firms may look more attractive in comparison.
Take China as an example. This is a nation that took a more impactful Covid-response for much longer. The re-opening boom that resulted when the government finally came around was lucrative, but there are signs that things are already starting to slow back down again. A number of metrics across construction and services activity dropped in May in a very consistent pattern:
Economic Gauges (CHINA) (Month over Month Change) (Yahoo Finance)
What I draw from this is that investors may actually find more shelter stateside than overseas. China's declining growth story is a major setback on a theme that I viewed positively just a few months ago. With geo-political risks rising and the government's efforts to juice the economy clearly showing some weakness, I think it is smarter for investors to stay either closer to home or in more developed, mature markets for the next few quarters.
Investors Love AI
Another great reason for going long Growth/NASDAQ at the moment is the rush in to "AI". This is a key reason why NVIDIA Corporation ( NVDA ) is now a top holding in VUG. Its recent performance has been stellar, with a big pop last week and very strong 1-year performance. While the chipmaker is benefiting from a rush to play the "AI" space, other Tech names are also benefiting. Think Microsoft ( MSFT ) (among others), which is also a top holding in VUG. The end result is that the rise in Tech shares is for very justifiable reasons and this is central to why this momentum play likely has legs.
What I am seeing in this market is that Tech leaders are giving investors what they want to here. That is going to drive investor interest (and dollars) into the space. People don't want to miss out on the next "big thing" and that is why I see less risk in the sector despite rising valuations.
For example, executives across Meta ( META ) Alphabet ( GOOG ), Microsoft and Amazon ( AMZN ) leaders mentioned "AI" almost 170 times in their most recent earning calls, according to a report from Fox Business. I see investors wanting more exposure to this space and business leaders are reacting to that. But linking their company with "AI" - however justifiable or not - that is going to create a long lasting buying frenzy, in my opinion. This is a transformational trend that is certain to warrant an allocation for many investors globally.
Rise In Distribution (YOY) Gives Comfort
My last topic relates to income - which is not a primary reason to own this fund (or growth/tech/nasdaq, etc.). But while the yield is not high, we can still find assurance in the distribution for other reasons. One such reason is the growth is the payout in Q1 2023 compared to Q1 2022:
VUG's Distribution Calendar (Vanguard)
I always enjoy seeing stats like this because it shows the underlying companies are managing their cash well, returning it to investors, and are most optimistic about the future than those that are cutting or simply maintaining their payouts. A growing yield is a critical factor when I look at positions - whether they are specifically dividend focused or not. For now, VUG passes this test easily.
Bottom-line
I have welcomed the Tech/NASDAQ rally in 2023 and I can't help but think the current trend has more room to run. Growth funds like VUG are filled with companies that are cash-rich, transformative, and have plenty of momentum. While I do have macro-concerns about the state of the U.S. economy and equity markets, I see major risks elsewhere around the world as well. This tells me to stick with what is working for now - and VUG is certainly working.
For further details see:
VUG: Large-Caps Are Leading The Way