Vanguard Mid Cap ETF: Cheap Valuations And High Quality (NYSEARCA:VO)

In this world nothing can be said to be certain, except death and taxes. – Benjamin Franklin

The Vanguard Mid Cap ETF (VO), a fund that is focused on mid-cap US stocks, has not been loved in recent years. It has had an impressive Covid-recovery, finally turning positive for the year, but remains below all-time highs made in February. Of course, this is not new for mid-cap investors. In the last three years, despite overwhelmingly positive equity markets and a risk-on sentiment, mid-caps have outperformed large caps, as measured by the Vanguard S&P 500 ETF (VOO). And by a significant amount, with a gain of 47.29% for the latter in the last 3 years to a gain of only 29.38% for the former.

Looking at the holdings of the ETF, the top 10 holdings account for only 8.1% of the portfolio, as much of the company-specific risk has been diversified away. Sector-wise, the holdings are balanced, with the top 3 sectors being Technology (21%) Financials (20.6%), and Industrials (15.3%). That gives a nice balance to the ETF in growth industries and value industries, which lets you hedge out the bet on which strategy will win out over the long term after more than a decade of growth stocks flourishing. Eventually, value investing can return, and you will have exposure to those types of companies with this holding.

Source: Vanguard

Thoughtful Selections

While the Covid crisis has many challenges for the mid-cap space, the portfolio has some excellent picks. For example, Lululemon Athletica Inc (LULU) is in a unique position, as their demand has likely increased with more consumers looking for comfort while working from home, a trend that the athleisurewear company has been excellent at capitalizing on. DexCom Inc. (DXCM) recently smashed earnings expectations in late July, with revenues gaining 34%, and earnings up a whopping 541%. SBA Communications (SBAC) managed to keep their dividend and beat FFO by $0.45, also beating on revenues, in their recent earnings report as more internet was used during the stay at home period. These, among other mid-cap plays, are extremely interesting in the ability to pivot and capitalize in a poor economy and should rebound stronger if the economy can continue its up leg.

Potential Risks

  1. If the economic recession is worse than thought, mid-caps may not have enough resources to weather the storm. Bankruptcies have been happening at an increased rate, especially when you go down the capitalization ladder, and could pose trouble throughout the rest of 2020 and into 2021, especially if government stimulus fails to gain traction in Congress. Many of these companies depend on a strong consumer.
  2. The dividend yield of VO could be under pressure here, especially if there is some movement on the political side to halt buybacks and shareholder payouts. While this remains a far-off risk, it is not implausible, and should be discounted as a risk when investing in these companies. With balance sheets that are inferior to larger-cap companies, there could be more pressure to keep free cash flow for future economic pullbacks and/or business pressure, lowering the dividend yield.
  3. This holding has 357 holdings currently, with a median market cap of $18.9 billion. While you are not going to be worried about diversification, you may suffer the effect of over-diversification with that many holdings. There have been studies done that say the proper amount of holdings for accurate diversification should be around 20-50 holdings only – at 357, the number is much higher.
  4. General market risk remains high after a Federal Reserve (Fed) fueled rally in 2020 off the March lows. If the Fed fails to stoke inflation, or they do not provide enough stimulus, stock markets are at risk of another major pullback. We saw some of this in the price action in early September, when tech stocks spurred a significant decline.

The ETF VO, and its underlying holdings, have shown a great ability to weather a downturn in the recent months. Although valuations remain elevated, at 25.3x P/E, the earnings growth rate of 13.7% should make up for that level over time. This is a great fund to get domestic exposure, as its foreign direct exposure remains 0%, and with a relatively low turnover of 15.2%, you should be comfortable holding this ETF long term.

While highly diversified, there are enough excellent ideas within the portfolio that can push the ETF to new highs, eventually. Whether the overall economy and markets remain in their uptrend is a huge question, but if you are looking for a 10- to 20-year investment, VO fits the bill. The nimbleness of mid-caps should allow them to adjust to the new normal economy, and if there is progress on a vaccine in late 2020 or early 2021, many will flourish.

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Vanguard comes to defense of the 60/40 portfolio as it forecasts stock market returns for the next decade

The 60/40 portfolio has come in for its share of criticism recently, with Bank of America proclaiming its death last year.

A 60/40 portfolio has 60% invested in stocks, and 40% in bonds or other safe asset classes. In a new note to clients, index fund powerhouse Vanguard Group points out how well the portfolio did in weathering the storm caused by the coronavirus pandemic.

A 60/40 portfolio — with 60% in the MSCI All Country World index
and 40% in a dollar-hedged Bloomberg Barclays Global Aggregate Bond index — weakened just 1.5% over the first half of the year.

“It is true that over a few days, the correlation between the global equity and bond markets was positive and that they moved relatively in tandem, but for the first half of 2020, a globally diversified bond exposure acted as ballast, helping to counter the riskier stock component of the portfolio,” says Joe Davis, global chief economist at Vanguard.

Vanguard is forecasting average annual U.S. stock-market returns between 4% and 6% over the next year, which isn’t dissimilar from a recent projection from Goldman Sachs. Vanguard says global stocks, to U.S. investors, will return between 7% and 9% a year. But despite Vanguard’s low return outlook for bonds — 0% to 2% for both U.S. and non-U.S. bonds — Davis says globally diversified fixed income will continue to play the important role of a risk diversifier in a multiasset portfolio.

Peter Dixon, senior economist at Commerzbank in London, is another who has come to the defense of the 60/40 portfolio. He points out that, over 20 years, it has generated higher returns than hedge funds once fees are taken into account.

“The current low rate environment means the returns from bonds are likely to look very poor for years to come. But investors tempted to overweight equities, which are likely to benefit as a consequence, run the risk of getting caught out by volatility as markets continue to question whether current price valuations are justified (we can expect quite a lot of that in the months ahead),” says Dixon. “Since the intention of 60/40 is to offset the extreme highs and lows of equities, it may be worthwhile sticking with it for a bit longer. It is, after all, a tried and trusted method and that is not a bad thing in our new, uncertain investment world.”

Strategists at Goldman Sachs disagree. In a note to clients this week, they acknowledge that over the last 30 years, there has been little benefit from diversification within equities or bonds, while diversification across assets was very effective.

But with bond yields closer to the effective lower bound, potential for further declines is limited, they say. As for stocks, equities are likely to be stuck in a “fat and flat” range, that is, below average returns with above average volatility.

They suggest an 80/20 portfolio with put protection, which they say outperformed a 60/40 portfolio significantly this year. Convertible bonds also look more attractive, they add.

The S&P 500

has rallied 46% this year from its March lows, and has gained a little over 1% this year. The yield on the benchmark 10-year Treasury

has fallen below 0.60%, falling 1.3 percentage points on the year. Yields move in the opposite direction to prices. 

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Will Vanguard step on the SPDR? This technology ETF just dethroned the industry leader

In mid-May, assets in the Vanguard Information Technology ETF

overtook those in a competing fund from the company that’s long dominated exchange-traded fund sector investing, the SPDR suite from State Street Global Advisors.

It was a small industry shift that perhaps only an ETF enthusiast would have noticed, yet it may speak volumes about how the investment-management world is evolving.

The Sector SPDRs were the first ETF products to track the S&P 500’s sectors — groupings of companies according to their business activities — and remain the industry giants, in large part because their scale enables institutional investors to use them to make big trades, said Todd Rosenbluth, head of ETF and mutual fund research for CFRA.

If Vanguard’s assets are catching up to State Street’s, it means one of two things, Rosenbluth told MarketWatch: either institutional investors are starting to get comfortable enough with Vanguard to rely on it as a trading tool — or that individual investors, who have traditionally comprised most of Vanguard’s customer base, are turning to “tactical” ETF strategies.

Vanguard cut its teeth in what the fund industry calls “core” products — simple index funds that track the overall S&P 500
for example. But individual investors are getting increasingly comfortable with exchange-traded funds, and increasingly using them to express more targeted views.

The attached chart shows 10 fund pairings of the currently existing 11 sectors. The 11th sector, real estate, was created in 2016; SPDR launched a fund to track the sector shortly before that. In contrast, Vanguard’s original sector lineup, which dates from 2004, has always included real estate. That fund has nearly $29 billion in assets, compared with $4.1 billion in the newer SPDR fund.

It’s only fair to point out that Vanguard’s footprint in the other sector funds remains quite small, compared against the corresponding SPDR funds. Next to real estate

and technology
health care

is the sector in which it has the largest presence, and there, its assets are still less than half those of the SPDR fund.

But Vanguard’s explosive growth rate is a story unto itself. The firm, once considered a financial-services underdog, now has more assets under management than its next three competitors combined. That’s thanks largely to individual investors.

See:Three fund managers may soon control nearly half of all corporate voting power, researchers warn

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Vanguard Extended Duration Treasury ETF: Expect It To Remain Rangebound In The Next Year (NYSEARCA:EDV)

ETF Overview

About 8 months ago, I have written an article to analyze Vanguard Extended Duration Treasury ETF (EDV). At that time, I was bearish because I thought the economy will gradually re-accelerate, especially after the trade deal between China and the U.S. is signed. However, the outbreak of COVID-19 has changed the macroeconomic outlook. Therefore, it is time for me to write an article to discuss the outlook of EDV again. EDV has little credit risk as its portfolio consists of U.S. treasuries that are backed by the full faith and credit of the U.S. government. Since the Federal Reserve will likely not raise its interest rate before 2022, and that it will not pursue negative interest rates, EDV’s fund price will likely be rangebound in the near term. Meanwhile, investors will be able to earn some interest income with an average yield to maturity of 1.5%.

Data by YCharts

Fund Analysis

EDV is very safe with extremely low credit risk

EDV tracks the Bloomberg Barclays U.S. Treasury STRIPS 20-30 Year Equal Par Bond Index. Therefore, its portfolio consists of mainly U.S. treasuries. U.S. treasuries are likely one of the safest bonds to hold on earth now as they have the best credit ratings. Since the formation of the U.S. government back in 1776, the government has never failed its lenders. In a post-COVID-19 world, we favor U.S. treasuries over government bonds issued by other emerging markets. Not only because most emerging markets have inferior credit ratings than the U.S. government, the U.S. has much better healthcare resources than many emerging markets. This is important because the U.S. has likely already passed the peak of the pandemic, while many other emerging markets have yet to reach the peak. Therefore, we think the economy in the U.S. will recover much more quickly and hence support its credit rating.

Source: Vanguard Website

EDV’s long average effective maturity year means its interest rate risk is high

EDV consists of U.S. treasuries that have long duration to maturity. As can be seen from the chart below, 100% of the treasuries that EDV owns will mature 20 to 30 years from now. In fact, it has an average effective maturity year of 25.3 years. Unlike short-term bonds, long-term bonds are much more sensitive to the change of interest rates because rates could change dramatically in the next 20 to 30 years. In a rising interest rate environment, bond value may decline dramatically. On the other hand, bond value will rise in a declining interest rate environment.

Source: Vanguard Website

The question is what the rate environment will be like in the next few years. Fortunately, we do not think the Federal Reserve will be in a hurry to move to raise its interest rate anytime soon. In fact, the Federal Reserve projects that interest rate will remain near zero at least until 2022. This is because many sectors are still hurting from the outbreak of coronavirus, and it is important to keep the interest rate low in order to support many suffering industries. Therefore, this low interest rate environment will likely stay for a lengthy period of time unless a vaccine is developed. This will likely not happen at least 1 or 2 years from now (perhaps even longer). For investors wanting capital appreciation, we do not think EDV is a good choice either. This is because the Federal Reserve has made it clear that it will not lower its rate into negative territory. Therefore, EDV’s fund value will likely be rangebound in the next 1 to 2 years.

Investor Takeaway

We think EDV’s fund value will be rangebound in H2 2020 and 2021. Meanwhile, investors of EDV will receive interest income with an average yield to maturity of 1.5%. Therefore, this may still be a good fund to own and earn some interest income in the near term.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.

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Vanguard names names and backs some calls for climate steps By Reuters

© Reuters.

By Ross Kerber and Sinead Cruise

BOSTON/LONDON (Reuters) – Vanguard Group, the world’s largest mutual fund manager, backed shareholder resolutions for shippers United Parcel Service Inc (N:) and J.B. Hunt Transport Services Inc (O:) and oil driller Ovintiv Inc (N:) to limit their climate-warming emissions, according to a top Vanguard executive and a company report being released on Thursday.

The details marked the first time the Pennsylvania-based firm has named names in describing such proxy votes at recent shareholder meetings.

In an interview with Reuters, Vanguard principal Glenn Booraem said the firm’s views on climate and its proxy votes reflect a growing consensus among investors and companies that businesses should account for the risks of operating on a warmer planet.

Climate change “is getting increasing attention at every level of the market,” he said.

Vanguard had raised climate concerns previously, without singling out companies by name or airing too much “dirty laundry,” as Booraem put it last year.

But with growing interest among investors about climate impacts, the new vote details are a way for Vanguard to show executives and its own clients how the firm puts its views into practice, Booraem said.

“We are on this climate journey and will continue to evolve, over time, at our own pace,” he said.

As a top shareholder in nearly every major U.S. company, Vanguard’s voice is often dominant in boardroom decisions. Vanguard manages some $6 trillion under management for 30 million mom-and-pop investors.

Traditionally Vanguard and its main rival, BlackRock Inc (N:), have backed shareholder climate resolutions only about 10% of the time. Critics, including Vanguard’s late founder, John Bogle, have long called for more transparency on how the asset managers vote.

Booraem declined to say what Vanguard’s overall support rate will be for climate measures this year, which will make up a tiny slice of the votes it will cast at roughly 13,000 companies worldwide during the 12 months ended June 30.

He declined to comment whether Vanguard would follow BlackRock in joining the Climate Action 100+ investor group seeking emissions cuts.

But Booraem said a report scheduled to be posted Thursday on Vanguard’s website includes specific examples that are meant to be representative of the company’s thinking on climate change. It aims to take a fiduciary approach and not an ideological one, he said, especially given the wide range of views among its clients.

The report shows that among nine shareholder resolutions voted on since April, Vanguard sided with management five times. For instance Vanguard voted against a proposal to have JPMorgan Chase & Co (N:) report how it would use its lending to cut emissions, saying the bank has already taken adequate steps.

In four other examples Vanguard sided with shareholders sponsoring the resolutions. One was a call for UPS (N:) to report on plans to reduce its climate-warming carbon emissions, saying UPS had failed to disclose how it would cut airplane fuel usage.

Vanguard also voted in favor of a proposal to have Ovintiv (N:) set emission-reduction targets, saying they would help investors understand the company’s strategy.

Vanguard’s votes did not determine the outcomes of the two questions. Public securities filings show at UPS 30% of votes cast favored the measure, a figure that would include Vanguard’s roughly 8% holding of Class B shares.

At Ovintiv 56% of votes favored the measure; Vanguard owns less than 1% of shares outstanding.

Representatives for UPS and Ovintiv declined to comment.

Vanguard did determine the outcome at J.B. Hunt (O:), where it holds about 10% of shares. A measure calling for the trucker’s plans to cut emissions — similar to what was asked of UPS — won support from 54% of votes cast, filings show.

A J.B. Hunt representative did not respond to requests for comment.

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