Equities have emerged as the unexpected winner across various asset classes this year, mostly driven by large cap technology companies amid the AI frenzy. That happened despite rising interest rates and inflation, as well as slowing economic growth across many major developed economies. It may be fair to say that mid-cap stocks, which are usually financially resilient with sound business models, have been overlooked by investors. Hence, it may be worthy to dive into the Vanguard Mid-Cap Index Fund ETF Shares (NYSEARCA:VO) to analyze its risk and performance, as well as the underlying fundamentals.
The fund “seeks to track the performance of the CRSP US Mid Cap Index, which measures the investment return of mid-capitalization stocks.” With that, it has a very diverse portfolio spanning across all sectors, led by technology, industrials and financial stocks. Meanwhile, its top 10 holdings are only 7.25% of the total fund weight out of its 345 holdings – an indicator for low concentration risk.
Performance & Peer Review
Comparing its performance against several peers in the US mid-cap space as well as the broad market as represented by SPDR® S&P 500 ETF Trust (SPY), VO tracked very closely to peers with ~8% YTD return but lagged behind the strong SPY performance with ~16% YTD return.
Over the longer period since January 2021, the returns across the peer group diverged as different ETFs tracked different indices. iShares Core S&P Mid-Cap ETF (IJH) and SPDR® S&P MIDCAP 400 ETF Trust (MDY), which are both based on S&P indices, have outperformed Vanguard Mid-Cap Index Fund ETF Shares (VO) and iShares Russell Mid-Cap ETF (IWR), which tracked CRSP and Russell indices, respectively. One key difference is in terms of sector exposures, where IJH is much more exposed to Industrials and Consumer Discretionary sectors as compared to VO, which have outperformed throughout the period.
While these funds are generally very low cost, VO stands out with only 4 bps of expense ratio as compared to its peers.
VO has similar annualized volatility (Jan’21-Aug’23) as compared to its peers at around 19%, which is slightly higher than SPY at ~16%. The 5Y Bollinger chart below also visualizes the price volatility of VO on a 3-month rolling basis, where it has been trading close to -1 sigma – indicating a potential oversold over the recent months.
Applying the Fama-French 3 Factor Model, ~40% of VO active risk relative to SPY can be attributed to size premium, where VO favors equities with smaller market cap relative to SPY holdings. This indicates that the ETF is doing what it is supposed to do. Meanwhile, about 11% of its active risk can also be attributed to value premium, where VO favors value stocks with higher book-to-market ratios.
Relative to the broad market, VO has underperformed since the start of 2023, as its rolling-alpha has always been in the negative territory, despite bouncing back from the trough recently. Meanwhile, the rolling-beta chart demonstrates the sensitivity of VO over SPY, which has been mostly trading above 1 and reaching 1.3 lately. This indicates higher volatility relative to SPY as 1 point move in SPY will lead to 1.3 point move in VO.
Fundamentals Deep Dive
Diving into the underlying fundamentals of VO, the fund has a weighted-average P/E ratio of 20.3x, which is lower than 23x in SPY, but much higher than the P/E ratio of its peers such as IJH at 14x. Therefore, IJH may be a better choice for investors seeking more conservative, value-focused mid-cap stocks as IJH also outperformed VO over recent years.
While its top holdings remain highly profitable from the return on equity standpoint, some suffered falls in revenue growth, such as Amphenol Corporation (APH) and ON Semiconductor Corporation (ON), which are both in the electronics industry.
Meanwhile, it is worth pointing out that these companies are in strong liquidity positions with quick ratio >1, and most companies with gearing ratio of <1 as well.
Generally, the street has priced in high expectations on these stocks with median target upside ranging from 6.5% for PCAR to 34.1% for ON – indicating positive sentiment overall.
For investors seeking mid-cap exposure, Vanguard Mid-Cap Index Fund ETF Shares may be a more growth-focused mid-cap portfolio as compared to its peer, IJH with more value-focused stock selections. In overall, VO has had worse risk-adjusted returns as compared to SPY. However, Vanguard Mid-Cap Index Fund ETF Shares underlying fundamentals remain robust across the top holdings – hence, investable for investors looking to diversify their factor exposures.