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ETF Specialist

A Broadly Diversified Gold Medalist

A best-in-class expense ratio and low turnover help this large-growth ETF stand out in a crowded, competitive category.

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In a category filled with strong performers, Vanguard Growth ETF (VUG) has emerged as one of the best funds available. Market-cap weighting leverages the collective expertise of a well-defined market, and robust index buffer rules mitigate turnover and the associated costs. This effective strategy comes at an extremely low price, as it carries an expense ratio of just 0.04%.

While the strategy itself is cheap, the stocks it holds are not. However, firms in this portfolio often warrant high valuations, as they are driven by promising growth outlooks and durable competitive advantages. Over 91% of this portfolio boasts a wide or narrow Morningstar economic moat, illustrating the enviable market position of these companies. Some firms will fall short of their lofty expectations, but large-cap stocks tend to be priced accurately due to the wide investor attention they receive.

Because this fund doesn’t make any sector-relative adjustments, its pursuit of growth leads to some sector biases relative to the broad market. Its tilts have proved advantageous over the past decade but may not pay off in the future. That said, this fund’s sector composition is highly representative of the Morningstar Category average, instilling confidence that its low fee will translate into solid category-relative returns.

This strategy’s market-cap-weighting approach and broad reach breed confidence in this fund as well. In addition to mitigating turnover, market-cap weighting channels the market’s collective view on the value of each holding and tilts the portfolio toward established industry leaders. This approach precipitates some concentration among its largest holdings. The 10 largest positions represent about 43% of the portfolio. However, these tend to be highly profitable industry leaders with durable competitive advantages.

Process
This strategy tracks the CRSP US Large-Cap Growth Index, which accurately and efficiently represents the opportunity set available to active large-growth investors. It yields a broad, well-diversified portfolio with lower turnover than almost all its category peers, supporting an Above Average Process Rating.

This benchmark pulls its constituents from the CRSP US Large-Cap Index, which features stocks representing the largest 85% of the total equity market. Each stock is ranked by its composite style score, which is calculated using six growth and five value metrics. These include standard measures like historical growth in earnings per share and return on assets, as well as book-to-price and sales-to-price ratios. Stocks representing the faster-growing half of the market are assigned to the growth index, while the others go to the CRSP US Large-Cap Value Index.

This index includes buffers that effectively mitigate unnecessary turnover. These buffers require a considerable change in style score for a stock to join the other style index. And if that occurs, the firm’s market cap is initially split evenly between the two indexes to ease the transition and protect against one-off fluctuations in the style scores.

Stocks in this index are weighted by market cap, which emphasizes the largest stocks, not necessarily the fastest-growing. This emphasizes the market’s top performers and gradually reduces exposure to stocks with declining prices.  

Portfolio
Firms that are poised for sustainable growth anchor this portfolio. Top holdings Microsoft (MSFT) (10% of portfolio), Apple (AAPL) (9%), and Amazon (AMZN) (8%) all have durable competitive advantages and attractive outlooks, typical of many of the firms the fund favors. However, performance relative to expectation is what counts. Growth stocks must live up to the high expectations embedded in their prices to provide competitive returns. That can be a tall order for some.

Some firms won’t deliver, but the fund’s well-diversified portfolio limits their impact. No sector receives disproportionate investment. This portfolio’s sector allocation mirrors the category average, amplifying the effect of the fund’s low fee. 

This strategy casts a wide net that limits its exposure to the most expensive and volatile growth stocks. Its index buffers keep stocks in the portfolio, even after they drift slightly into value territory. For example, this fund continues to fully invest in McDonald’s (MCD) even as it has steadily gotten cheaper.

Most index growth strategies, like Russell 1000 Growth and S&P 500 Growth, opt to partially allocate blend and value stocks between their indexes and their value counterparts. In contrast, this strategy keeps stocks fully allocated to their original style index until they pass through a buffer. This approach better mitigates turnover, while keeping the portfolio’s growth orientation in line with the category average.

People
This fund is managed by a capable, seasoned group. The team’s extensive experience and strong trading infrastructure have enabled efficient index-tracking, warranting a People Rating of Above Average.

This strategy falls under the purview of the Global Equity Index Group with Gerard O’Reilly and Walter Nejman as the named managers. O’Reilly has managed this fund since its 2006 inception and has been with Vanguard since 1992. Nejman joined him as a comanager in 2016 and began with the firm in 2005.

Vanguard takes a team approach to index portfolio management. Managers in the group can provide backup if necessary, but much of the day-to-day management operations have been automated. This improves efficiency and softens the impact of personnel turnover. Additionally, managers draw on an Index Analytics team for insight on upcoming changes to underlying indexes.

The team’s primary focus is minimizing return difference between the portfolio and its index. Vanguard links managers’ compensation to their success in delivering on this objective, aligning manager and investor interests.

Performance
This strategy has turned in sound long-term performance relative to its category peers. The Institutional share class beat the category average by 193 basis points annually over the trailing 10 years through April 2020, owing to its cost advantage, lower-than-average cash drag, and favorable exposure to communications stocks.

This fund is always fully invested. This has helped performance during market rallies, and while it hurts during market downturns, the fund has turned in respectable performance during those periods. For example, this strategy outperformed the category average by 2.28 percentage points during the market downturn from Oct. 9, 2007, through March 9, 2009, largely due to more favorable stock exposure in the industrials sector.

This strategy’s true performance edge lies in its extremely low cost. Its 0.04% expense ratio is one of the category’s cheapest, and its low turnover mitigates transaction costs.

Diligent portfolio management and full index replication have kept tracking error low. This fund trailed its benchmark by just 4 basis points annually over the trailing five years through April 2020, a mark that is even with its expense ratio.

Ryan Jackson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.