2023-07-25 05:43:18 ET
Summary
- Vanguard's Large-Cap Index Fund offers low-cost exposure to the largest US public companies, but faces a challenging environment due to the Fed's policy to combat inflation.
- VV has shown marginally better performance over the past decade compared to other large-cap ETFs, but is slightly overpriced compared to its peers.
- For long-term investors, VV offers a strong risk/return tradeoff and is well diversified, making it a good addition to their portfolio despite the tough outlook for large-cap equities.
Thesis
The Fed's policy to combat inflation has captured overwhelming attention from investors and analysts over the past couple of years, as increasing interest rates have raised uncertainty for equity investments. Especially Large cap equities find themselves in a precarious position, transitioning to the second half of 2023.
Vanguard's Large-cap Index Fund ( VV ) is one the more popular large-cap dedicated ETFs in the market as it offers low-cost exposure to the largest public companies in the U.S. In this analysis, I explore the outlook for the fund, in the context of the broader interest rate macroeconomic challenge, as well as its individual and comparative performance and valuation.
VV ETF Identity
Vanguard's Large-Cap Index Fund is one of the most popular large-cap ETFs in the market, tracking the CRSP US Large Cap Index and offering investors targeted exposure toward U.S. large-cap equities. The fund was incepted in 2004, has approximately $29B of Assets Under Management, charges a low 0.04% expense ratio and pays a 1.44% dividend yield.
In terms of sector allocation, VV is overweight toward technology (32.30% of total weighting), while also recording significant exposure in the Consumer Discretionary (14.40%) and Healthcare (12.90%) sectors. VV's sector composition is rather similar to that of an S&P 500 or Russel 100 ETF.
Rate Hikes Worsen the Outlook for Large Caps
After several rate hikes by the Fed, the effective Fed Funds Rate has now climbed over 5%, reaching levels unseen since the early 2000s. Interest rates act like gravity to asset prices and valuations, and considering the multiple expansion the market (especially tech-heavy large caps) has seen over the past few years, it is hard to see how this challenging environment can leave much room for strong rallies in the near term.
Even though the broader market has somewhat recovered from the 2022 downturn as inflationary pressures appear to be easing, it is probably too soon to expect falling interest rates as they might cause another inflationary explosion that the Fed simply does not want. Historically, rates have stayed above the 5% mark for long periods of time, and if that were to repeat the outlook for large-cap equities seems to offer limited upside.
Large Cap ETF Comparison
In the large-cap ETF universe, there is no shortage of large-cap exposure through almost every broad index ETF. A few more dedicated, large-cap-focused funds however are available for investors and are given a comparative analysis in this segment. The ETFs considered besides VV are iShares Russell 1000 ETF ( IWB ), Schwab's U.S. Large-Cap ETF ( SCHX ) and Vanguard's Mega Cap Growth ETF ( MGK ).
While all three large-cap ETFs have very similar characteristics and performance, Vanguard's Mega Cap ETF is much more concentrated and has clearly outperformed; which was expected given the market's favorable treatment of mega-caps, especially in the tech space, over the past few years. This outperformance, however, has also made MGK much more vulnerable, given its inflated valuation and concentration around few companies.
Among the three large-cap funds, VV has shown marginally better performance over the past decade, while charging the second-lowest expense ratio at 0.04%. VV also has the largest average market cap, as well as the higher valuation multiples (P/E of 22.16x and P/B of 4.02x), which indicates that it is also slightly overpriced compared to its peers.
Large Cap Factor Performance
Considering that VV is a blend large-cap ETF offering exposure towards both value and growth stocks (yet primarily towards growth ones due to their dominance in the markets recently), it is important to examine how the ETF compares to its value and growth large-cap counterparts. To this end VV's performance is compared to Vanguard's Value ETF ( VTV ) and Vanguard's Growth ETF ( VUG ), using the tools offered by Portfolio Visualizer. The backtest goes back to 2004 and annual dividend reinvesting is assumed.
As expected, growth has been the dominant factor over the past 15+ years, with VUG recording an annualized 10.62% growth compared to VTV's 8.45% and VV's 9.58%. Overall, VV outperforms VTV and underperforms VUG in risk- adjusted performance. All three funds are highly correlated to the broader market.
After considering that for a decades of stock market history the value factor has recorded an edge in performance (what investors call the value effect) and that recently ETFs like VTV have underperformed, doubling down on the value factor at this point in time seems like the smart move. For a more conservative and less active investors however, going with a blend ETF like VV, grants him/her exposure to both factors, while promising strong long-term gains, to a great extent regardless of the value vs growth positioning in the market. Overall, VV offers respectable risk/return performance.
Final Thoughts
After all things are considered, I believe it is fair to say that large-cap equities currently face a tough outlook going forward, at least over the near term. That said, for the long-term investor it can never really be a terrible time to add to his/hers position, especially through a proven, well-performing ETF like Vanguard's Large-Cap Index Fund. VV is well diversified and offers a strong risk/return tradeoff, despite being, currently, slightly overvalued compared to a couple of its peers.
For further details see:
VV ETF: Rate Hikes Worsen The Outlook For Large Caps