VOT: Portfolio Of Mid-Cap Stocks Delivering High Returns Over The Long Run

~ by Snehasish Chaudhuri, MBA (Finance)

Vanguard Mid-Cap Growth ETF (NYSEARCA:VOT) is an exchange traded fund that invests in growth stocks of mid-cap companies operating across diversified sectors. The fund passively provides growth exposure within the entire US mid-cap space. It has $10.8 billion in assets under management, with a low expense ratio of only 0.07 percent. Turnover ratio of 0.22 percent is well under control.

Experience and stability of Vanguard Group have enabled sophistication in portfolio management techniques that helped the group in reducing tracking error. Vanguard’s refined indexing process, combined with low management fees and lower errors has resulted in such a low expense ratio. VOT generates low yield, but at the same time delivers significantly high average total returns.

Vanguard Group Employs Sophisticated Portfolio Construction & Trading Strategies

Vanguard Mid-Cap Growth ETF was formed on August 17, 2006 by Vanguard Group, Inc. The group has developed sophisticated portfolio construction methodologies and efficient trading strategies that seek to deliver returns that are highly correlated with target portfolio benchmarks. The group has been advising Vanguard Mid-Cap Growth ETF for the past 18 years. VOT employs an indexing approach designed to track the performance of the CRSP US Mid Cap Growth Index. This index measures the return of mid-cap growth stocks. VOT’s fund managers are more stringent while picking stocks within the index.

CRSP US Mid Cap Growth Index selects growth companies based on their historical earnings and sales growth, internal growth rates, and forecasted earnings growth. Stocks are provided scores and then ranked based on the composite scorers obtained by these growth factors. This also becomes the basis of their weightage within the index. The advisor of Vanguard Mid-Cap Growth ETF attempts to replicate this target index by replicating substantially all of its assets in the stocks that make up the index, holding each stock in almost the same proportion as it has been in CRSP US Mid Cap Growth index.

Despite Being a Mid-Cap Fund, VOT Possesses Characteristics of Large-Cap Funds

Average market capitalization of the various mid-cap stocks included in VOT’s portfolio stands at $27.25 billion. Now, this is way above the average market capitalization of mid-cap funds. According to Morningstar, the average market capitalization of similar US based mid-cap funds is $19.79 billion. On studying its composition in detail, I found that almost 19 percent of the entire holdings of Vanguard Mid-Cap Growth ETF is made up of large-cap stocks.

Vanguard Mid-Cap Growth ETF invests 61.25 percent of its entire holdings in three sectors – information & communication technology (ICT), healthcare and industrial. These are the three sectors that not only are having huge growth potential, but also have an omnipresence of mid-cap stocks. This exchange traded fund is well-diversified, but at the same time bit more concentrated than most mid-cap & small-cap funds. Its top 18 holdings account for less than 25 percent of its entire assets. It’ll not be unfair to say that despite being a fund of mid-caps, VOT possesses a lot of characteristics of large-cap funds.

This Low-Yielding Fund Generates Relatively High Total Returns Over the Long-Run

Vanguard Mid-Cap Growth ETF has been offering quarterly pay-out since the past 32 quarters on a regular basis. However, it fails to generate yield that will satisfy the needs of income seeking investors. Annual average yield over the past 10 years was only 0.7 percent. However, the good thing is this ETF generates consistent price growth, which enables VOT to post strong annual average total returns. VOT’s year-to-date total return stands at 11.79 percent. Between 2016 and 2021, annual average total return stood as high as 19 percent. During the same period, S&P 500’s total return was marginally lower at 18 percent. 2022, undoubtedly, was a poor period for the broader market.

Stocks in VOT’s Portfolio Have High Average Price Multiples & Higher Growth Rates

Funds like Vanguard Mid-Cap Growth ETF that invest in mid-caps may suffer liquidity issues that steer many investors away. Biotechnology companies, which generally happen to deal with pipeline drugs thus, create some inherent risk. Fortunately, the share of biotechnology stocks is not overwhelming. On the other hand, mid-cap technology companies have a history of growing out of mid-cap space and entering the world of large-cap stocks. Mid-cap industrial stocks, though not that successful, are more focused on new-age technology, than scale, and thus have huge prospects in the years to come.

But there lies a concern about such stocks getting overvalued, which can be understood by the high average price multiples of the component stocks in VOT’s portfolio. Currently this mid-cap ETF has an average price to equity (P/E) ratio of 25.06, price to book (P/B) ratio of 4.15, average sales growth of 17.63 percent, and an earnings growth of 28.6 percent. This price multiples and growth rates are much higher than the index and its peers. The index also does not seem to be mindful of natural sector differences like higher multiples inherent to the IT and lower multiples in the case of, say, utilities or energies.

Investment Thesis

Vanguard Mid-Cap Growth ETF is an exchange traded fund that invests in growth stocks of mid-cap companies operating across diversified sectors. Vanguard Group’s refined indexing process, combined with low management fees and lower errors has resulted in a low expense ratio. VOT’s asset base of $10.8 billion generates low yield, but delivers significantly high price growth. Between 2016 and 2021, VOT’s annual average total return surpassed that of S&P 500. This low-yielding fund fails to fulfill the needs of income-seeking investors, but can be a good choice for long-term growth-seeking investors.

Some investors are skeptical about investing in mid-caps, as they fear that these stocks are relatively riskier than the large-caps and may suffer liquidity issues. Fortunately, Vanguard Mid-Cap Growth ETF is little different from average mid-cap funds. It invests significantly in technology-oriented mid-cap stocks, which have a history of growing out of mid-cap space and entering the world of large-cap stocks. VOT’s sales and earnings growth rates are much higher than the index and its peers. But at the same time, its price multiples are high too. It is also trading at a marginal premium to its net asset value. Considering all these above factors, I would recommend a hold on this fund.

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