Fund Spotlight: Vanguard Value Options

Vanguard Value (NYSEARCA:VTV) outperformed all the major indexes in 2022, declining only 2.07 percent. It was one of many value-oriented indexes and funds that beat the major indexes, thanks to avoiding the worst-performing sectors. Technology and technology-related companies such as Amazon, Meta, Netflix, Google and Tesla were anchors of growth sectors. Conversely, energy enjoyed a substantial double-digit gain. Utilities, consumer staples and healthcare, typically overweight in value funds, saw small gains or losses.

Aside from the aforementioned value sectors, Vanguard Value also has hefty positions in financial companies. Financial firms trade positively, with interest rates relative to the broader stock market because rising rates lift the earnings of financial assets. Valuations of stocks and bonds are negatively affected, but the income stream from bank loans rises. Insurance companies’ earnings rise as the interest paid on their large bond holdings increases.

Last year showed that random events can determine which sector leads the market. Russia’s invasion of Ukraine sent oil prices soaring in the first half of the year. Energy was far and away the best-performing sector as a result. If this year continues the trend of the last months of 2022, energy will struggle with a repeat performance. Many energy consumers adjusted to higher prices and Russia sanctions, the result being depressed energy prices. Crude oil and natural gas are flat over the past year, having given back all their 2022 gains.

Lower energy prices are great news for energy consumers, meaning virtually all of us. Lower inflation will lift pressure on financial asset valuations, particularly if interest rates stabilize. Lower energy costs will help energy-intensive industrial companies. Shipping costs are already tumbling internationally, but domestic supply-chain woes have kept diesel prices artificially inflated. If those can drop, consumer price inflation will slide even more than anticipated.

If we condense the past three years of market history into a paragraph, it was a story of a blow-off relative top in growth stocks followed by growth giving it all back. Tech stocks led during the pandemic, since they benefited from lockdown policies, including fiscal stimulus amid low inflation. As inflation picked up, the tailwind for growth started turning into a headwind. Value stocks started outperforming as growth stalled. Last year, growth gave back most or all of its gains, depending on the index. For example, since March 1, 2020, VTV has risen 46.78 percent. Vanguard Growth (VUG) has gained 26.57 percent over the same period. At the start of 2022, VTV was up about 50 percent from March 1, 2020, and VUG was up 85 percent. A similar shift happened with the Dow Jones Industrial Average and Nasdaq. The latter had a big lead in 2020 and 2021, but now the two indexes have sported similar returns since the onset of the pandemic.

The big question moving ahead is whether the bull market in growth resumes or whether the past year was the start of a major shift to value stocks. Given that inflation and interest rates are still elevated, along with strength in areas such as emerging markets that comport with value leadership, it looks like a shift in market leadership is underway.

Vanguard Value (VTV)
Vanguard Value tracks the CRSP US Large Cap Value Index. It has an expense ratio of only 0.04 percent and a 30-day SEC yield of 2.48 percent.

VTV has an average market capitalization of $108 billion, not far off the Large Value category average of $115 billion or the index average of $104 billion. It has substantially less in giant caps than the category though, at 37 percent versus 46 percent, while being in line with the index’s 38 percent. VTV’s large- and mid-cap exposure is also similar to that of the index.

Sector exposure is similar to the Large Value category, but VTV deviates in favor of value. Technology, communication services and consumer discretionary all are underweight. Healthcare, industrials, and consumer staples are overweight. Healthcare is the largest sector, with 22 percent of assets, followed by financials at 20 percent, industrials at 12 percent, consumer staples at 11 percent and energy at 8 percent.

The top 10 holdings in VTV as of November 30 were Berkshire Hathaway (BRK.B) at 3.10 percent of assets, UnitedHealth Group (UNH) 2.87 percent, Johnson & Johnson (JNJ) 2.62 percent, Exxon Mobil (XOM) 2.60 percent, JPMorgan (JPM) 2.27 percent, Procter & Gamble (PG) 2.00 percent, Chevron (CVX) 1.81 percent, Eli Lilly (LLY) 1.78 percent, AbbVie (ABBV) 1.60 percent and Pfizer (PFE) 1.58 percent.

VTV has a beta of 0.90 and a standard deviation of 20.50, compared with 0.94 and 21.75 for the category, making it slightly less volatile than the competition.

VTV has 1-, 3-, 5- and 10-year annualized returns of negative 2.23 percent and positive 8.66 percent, 8.37 percent, and 11.77 percent.

It has outperformed the category and index in every period.

Vanguard Mega Cap Value (MGV)
Vanguard Mega Cap Value has almost the exact same performance as VTV, with 1-, 3-, 5- and 10-year annualized performance of negative 1.82 percent and positive 8.71 percent, 8.69 percent and 11.87 percent.

MGV is slightly more expensive, with a 0.07 percent expense ratio, and this impacts the 30-day SEC yield, which is slightly lower, at 2.44 percent.

The top 10 holdings in MGV are identical to VTV, but with different weights. MGV’s top holding was UnitedHealth Group at 3.52 percent of assets, and the tenth holding, Pfizer, had 1.93 percent as of November 30. MGV is the more concentrated fund, with more assets in the largest companies. As a result, it has an average market capitalization of $158 billion.

MGV also has more assets in healthcare, at 25 percent of assets, almost 3 percentage points more than VTV, but the other sectors are similar. Performance shows this difference in healthcare hasn’t had a large impact on returns going back as far as 10 years. On the plus side, MGV has slightly lower volatility, thanks to its larger market capitalization. Investors aiming for low volatility may prefer MGV for this characteristic; otherwise, VTV has a slight edge on expenses.

Value won 2022 because losses were concentrated in growth stocks. Value investors didn’t see large gains unless they placed hefty bets on the highly volatile energy sector. Otherwise, their outperformance was driven by what they didn’t own.

The factors that drove growth losses last year, such as inflation, higher interest rates and deglobalization, are positive for value stocks. Unless those factors reverse, value stocks will have an edge no matter whether the broader stock market rises or falls. If inflation and rates go higher than expected, losses will again be concentrated in technology, while a shift into a stronger economy will benefit earnings at industrial companies. One major industrial stock and DJIA component, Caterpillar (CAT), has already made a new all-time high in 2023. Conversely, Apple opened the year with a new 52-week low.

Broad value funds such as VTV can serve as core holdings within a diversified portfolio. Investors using value funds are most at risk of being overweight healthcare or financials if they hold separate sector funds in these areas. Unless an investor has all their portfolio in value funds, they probably aren’t very overweight energy or materials. Aggressive investors who want a little more risk probably have room for a small additional position in sector funds such as Vanguard Energy (VDE), but with a bearish outlook at the start of 2023, it may pay to wait some months before buying.

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