MGK: Potentially From First To Worst

The pressure to perform is actually a privilege. Being left out of the starting rotation is a sign you must work harder. – Julie Foudy.

I continue to sound the alarm on conditions that favor a credit event, potentially beginning next month in September. For all the talk around it being a “new bull market,” the reality is that a rising tide has not lifted all boats. The only boat that really has risen is the largest of all, and that’s exactly why large-cap growth is very vulnerable in my opinion.

The issue is that it’s been a story of just a select number of large-cap tech names that are leading, while everything else is lagging. The Vanguard Mega Cap Growth Index Fund ETF Shares (NYSEARCA:MGK) is an exchange-traded fund, or ETF, that aims to track the performance of the CRSP US Mega Cap Growth Index. This index represents the growth companies of the CRSP US Mega Cap Index, which includes approximately the top 70% of companies in the U.S. equity market. MGK offers diversified exposure to the largest growth stocks in the U.S. market and employs a passively managed, full-replication approach.

It’s clearly worked. But if we look MGK divided by the iShares Russell 3000 ETF (IWV), we can see momentum on a relative basis may finally have peaked.

MGK’s Top Holdings

The holdings of an ETF provide insights into its investment strategy and potential performance. As of June 30, 2023, MGK held 96 stocks, with technology having a 55.9% allocation on a sectoral basis. The ten largest holdings of MGK accounted for 62.5% of its total net assets. These include:

1. Apple Inc. (16.2%)
2. Microsoft Corp. (14.1%)
3. Alphabet Inc. (7.3%)
4. Amazon.com Inc. (6.3%)
5. NVIDIA Corp. (5.0%)
6. Tesla Inc. (3.9%)
7. Meta Platforms Inc. (3.5%)
8. Eli Lilly & Co. (2.2%)
9. Visa Inc. (2.1%)
10. Mastercard Inc. (1.9%)

These companies are industry leaders with strong global brands, robust market positions, impressive records of innovation, and significant positions in Artificial Intelligence (“AI”). They also boast strong balance sheets with large cash positions and generate robust free cash flow. Having said that, they are also the most crowded parts of the marketplace.

MGK vs. Peers: A Comparative Analysis

Let’s face it – there are tons of large-cap growth ETFs. Some of the close peers to MGK include the Schwab U.S. Large-Cap Growth ETF (SCHG), Invesco QQQ Trust (QQQ), and Vanguard S&P 500 Growth ETF (VOOG). All these funds have largely performed the same over the long term. It’s worth mentioning here that when it comes to expense ratios, MGK scores well with a low expense ratio of just 0.07%, which is significantly lower than the average expense ratio of 0.96% for large-cap growth funds. This low expense ratio means that a larger portion of the investment returns goes to the investors rather than being spent on fund management expenses.

Risk Factors and Investment Considerations

The problem I have here is more a function of timing and concentration risk. More than 55% of the Vanguard Mega Cap Growth Index Fund ETF Shares is Technology.

Maybe this is a feature and not a bug, but it is undeniable that it’s a concentration risk for the fund. Any downturn in the technology sector can significantly impact the performance of MGK. Furthermore, investors should also consider the valuation of the ETF. As of June 30, 2023, MGK was trading at a price-to-earnings (P/E) ratio of 38.5x and a price-to-book (P/B) ratio of 10.0x. These figures are relatively high, indicating that the ETF may be overvalued, and meaningfully so.

Final Thoughts

I just don’t think Vanguard Mega Cap Growth Index Fund ETF Shares is worth allocating to here. Stocks broadly look vulnerable to a correction, with Technology likely taking the biggest hit just given how well it’s performed so well. Value has gotten destroyed by Growth, but that could change in the very near future.

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