gopixa
~ by Snehasish Chaudhuri, MBA (Finance)
Vanguard Extended Market Index Fund ETF Shares (NYSEARCA:VXF) is an exchange traded fund that seeks to track the performance of the Standard & Poor’s Completion Index, by using representative sampling techniques. S&P Completion Index measures the performance of small-cap and mid-cap stocks listed in the US stock markets. VXF pays quarterly dividends with a low yield i.e. below 1.5 percent. But the fund has been generating strong average total returns over the long run. It has a 0.06 percent expense ratio and $13.4 billion of assets under management. VXF looks fundamentally sound, and the fund may generate strong returns in case the mid-cap & small-cap stocks appreciate relative to the broader market. The fund is currently trading at a negligible discount of 0.05 percent.
VXF selects Stocks That Are in Demand, Its Portfolio Has Very Little Concentration
Vanguard Extended Market ETF is relatively well-diversified across different sectors. Information & communication technology (ICT), industrial, healthcare and financial sectors together account for 67.3 percent of its entire portfolio. If we compare VXF’s holdings with any other large-cap fund or with S&P 500 index, we can find that the technology sector accounts for a relatively smaller proportion (22.74 percent) in VXF as compared to almost 30 percent in other funds. In addition to being well-diversified across sectors, VXF also exhibits little concentration, with its top 10 holdings accounting for almost 8 percent. Ten largest stocks in S&P 500 account for over 25 percent of the entire index.
Vanguard Extended Market ETF was launched and is managed by The Vanguard Group, Inc. It invests in growth and value stocks across diversified sectors in the US economy. Like most of the large-cap diversified US equity funds, VXF also had 60 percent of its top 20 investments were in technology focused stocks. However, unlike those large-cap funds, these 12 stocks accounted 9.05 percent of VXF’s entire portfolio. A look into these 12 stocks reveals that most of these companies are in strong demand in current days.
Top Technology Holdings Delivered Price Growth, But their Proportion is Quite Low
Uber Technologies, Inc. (UBER) and Airbnb, Inc. (ABNB) are data servers that are prominent players in the transportation and real estate sectors. CrowdStrike Holdings, Inc. (CRWD) and VMware, Inc. (VMW) are developers of system software; Workday, Inc. (WDAY), Palantir Technologies Inc. (PLTR), HubSpot, Inc. (HUBS) and Datadog, Inc. (DDOG) are developers of application software. Marvell Technology, Inc. (MRVL), Snowflake Inc. (SNOW) and MongoDB, Inc. (MDB) are operating in the field of internet Services, data and related infrastructures, while Block, Inc. (SQ) is engaged in transaction & payment processing services. All these stocks have done reasonably well during 2023. Vanguard Extended Market ETF also generated a total return of 14.5 percent.
VXF Has Been Successful in Generating Above-Average Total Returns Through-Out
Vanguard Extended Market ETF invests by sampling S&P Completion index, meaning that it holds a broadly diversified collection of securities that, in the aggregate, approximates the full index in terms of key characteristics. These characteristics include market capitalization, financial fundamentals, industry weightings, dividend yield, price multiples, etc. Invested in 3,660 stocks with a turnover ratio of 11 percent, VXF’s median market capitalization stands at $6.1 billion, which is not extremely low. So, from that perspective, VXF is investing primarily in mid-caps, which are in general value stocks by nature.
Mid-cap stocks have been impacted relatively less than their large-cap peers in response to the twin shock of covid-19 pandemic and Russia’s invasion of Ukraine. As a result VXF recorded a trailing-twelve-months (TTM) return of 10.82 percent and year-to-date (YTD) return of 15.65 percent. Annual average total returns over the past five years also have been decent at 5.5 percent. Low concentration in a particular stock and greater sectoral diversification are some of the key characteristics of Vanguard Extended Market ETF that enabled the fund to mitigate the higher risk such mid-cap stocks bring along.
Small-cap and Mid-cap Equities Have Underperformed Their Large-cap Counterparts
Over the past 10 years, both small-caps and mid-caps have underperformed their large-cap counterparts, primarily due to the rallies led by technology giants and consumer discretionary conglomerates. 10-year trailing return for the S&P 500 was 288.7 percent, whereas S&P MidCap 400 and Russell 2000 small-cap index generated returns of 214 percent and 182.6 percent, respectively. However, those rallies were briefly interrupted by some global events during the past few years. These changed the scenario in favor of diversified small-cap and mid-cap funds like Vanguard Extended Market ETF.
Mid-caps and small-caps are often-overlooked by the market, but these stocks have the potential of generating strong capital growth as they are believed to be strong acquisition targets. Mid-caps and small-caps are often undervalued as compared to the large-caps with respect to long-term price multiples. So, they are likely to outperform over the coming years. For instance, S&P MidCap 400 is currently trading at 14.4x compared to its 10-year average PE of 19x and 20-year average PE of 18.1x. Whereas, S&P 500 is trading at 17.5x, above its 20-year average of 16.8x. So, large-cap stocks appear to be overvalued and therefore more likely to underperform in the short-term relative to mid-caps.
Investment Thesis
Vanguard Extended Market ETF pays quarterly dividends with a low yield. But the fund generates strong total returns. The fund may outperform the market in case the mid-cap & small-cap stocks appreciate relative to the broader market. VXF’s median market capitalization stands at $6.1 billion, which is not extremely low. Mid-cap stocks are currently trading at a lower PE than their historical average. The technology sector accounts for a relatively smaller proportion in VXF as compared to that of large-cap funds or that of S&P 500 index. Low concentration risk and greater sectoral diversification also enabled this fund to mitigate the higher risk such mid-cap stocks usually bring along.
However, there is some concern about the future price performance of this fund, as mid-cap and small-cap stocks may fail to register growth in case of a global recession. These stocks usually have less volume than their large-cap peers, and also underperform them. A low turnover ratio of 11 percent means there is little scope for an overhaul of VXF’s portfolio. Moreover, the fund generates a very low yield of almost 1.3 percent. In the absence of price hike, this fund’s yield will not fail to even beat the current level of inflation. The fund is also currently trading almost at par with its net asset value of $152.7. Thus, I would suggest a hold for the investors of Vanguard Extended Market ETF.
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