VTI - Overview
The Vanguard Total Stock Market ETF (NYSEARCA:VTI) is a broad-based all-cap U.S. equity index ETF.
VTI tracks the CRSP U.S. Total Market Index, which encompasses nearly 100% of the U.S. investable equity market, and includes equities of all relevant sizes and industries. As with most equity indexes, there are certain inclusion criteria, centered on liquidity, size, and the like, but these are quite lax. If it is a U.S. public equity, it likely is included in the index, and in the fund.
VTI's investment strategy and holdings confer important benefits and drawbacks to the fund and its shareholders. Let's have a look at these, starting with the benefits.
VTI - Investment Thesis and Benefits
Diversified Holdings
VTI's underlying index is quite broad, with comparatively few inclusion criteria, and with no set number of holdings. VTI's underlying index results in an incredibly well-diversified fund, with just under 4000 holdings, and with exposure to all relevant industry groups.
(Source: Vanguard Corporate Website)
VTI's diversified holdings serve to reduce portfolio risk and volatility, are a significant benefit for the fund and its shareholders, and are a core benefit of the fund. VTI provides exposure to all relevant U.S. equities, and so the fund could easily function as a core long-term holding. It has everything the U.S. market offers, and everything investors need.
Although most broad-based U.S. equity indexes are diversified too, VTI is really in a class of its own. Most other equity indexes, including the S&P 500, have narrower inclusion criteria, a smaller number of holdings, and generally focus on large-cap stocks. The Vanguard S&P 500 ETF (VOO), for instance, just invests in the (500) S&P 500 stocks, meaning 3500 fewer holdings than VTI. VOO is missing most of VTI's holdings, and so is sorely lacking on the diversification front versus VTI. Funds like VOO also specifically lack exposure to small-cap equities.
As mentioned previously, the average broad-based equity index fund is closer to VOO than to VTI, and so the latter's diversification is a key benefit and advantage.
Strong Market-Beating Returns
VTI provides investors with quite a bit of diversification and strong, market-beating returns, a solid combination.
VTI's returns are quite strong on an absolute basis. The fund's annual returns have averaged 8.9% since inception, more than 20 years ago. Performance is, if anything, accelerating, with VTI posting double-digit annual returns for the past decade, and counting.
(Source: Vanguard Corporate Website)
VTI's returns are strong on an absolute basis due to the fund's focus on (U.S.) equities. Remember, equity returns tend to be quite strong, as equities entitle shareholders to underlying corporate profits, and corporate profits are generally high, and tend to increase. VTI's shareholders should see their fair share of profits from companies such as Apple (AAPL), Microsoft (MSFT), and Amazon (AMZN), and these are very profitable companies, and becoming more so every year.
As per management data, VTI's underlying holdings have an earnings yield of 4.1%, and an earnings growth rate of 18.8%. Expect significant shareholder returns if these results are maintained, and they generally are.
VTI's returns are also quite strong on a relative basis, with the fund outperforming the S&P 500 since inception, and by quite a bit.
VTI's comparatively strong, market-beating returns are due to the fund's small-cap equity exposure.
Some context first.
Academic research has shown that there are certain investment factors which tend to generate excess returns.
One of these factors is (small) size.
Smaller companies tend to outperform, as their smaller size facilitates further growth, and as smaller companies tend to be more cheaply valued, due to their riskiness. For decades, the smaller the company the higher the returns.
(Source: MSCI)
So, smaller companies outperform, which that increased exposure to smaller companies leads to outperformance. VTI is more exposed to these companies than most other broad-based equity indexes, including the S&P 500, and so tends to outperform.
This is easier to show with an example.
Moderna (MRNA) has been one of the most successful companies and investments of these past few years. The company successfully developed an incredibly effective coronavirus vaccine, based on cutting-edge mRNA techniques. This is an incredibly scientific achievement, and only matched by BioNTech (BNTX) and Pfizer (PFE), who developed and manufactured a similar vaccine. Similar vaccines and products are on the way. Moderna is extremely well-positioned to develop more of these, which should lead to strong revenue, earnings, and share price growth in the coming years.
Moderna has, understandably, being one of the best-performing stocks of the past few years, significantly outperformed the S&P 500 since inception. It is not particularly close.
VTI, being an all-cap equity index fund, invested in Moderna very early. Although I'm unable to get an exact date, from looking at VTI's underlying index, I'm confident the fund invested in the company soon after its IPO. Doing so allowed VTI, and its shareholders, to profit from the company's meteoric rise.
The S&P 500, on the other hand, added Moderna to its index very late in the game, in July 21st 2021. Moderna had already developed, manufactured, and shipped hundreds of millions of vaccine doses by that date, and so the vast majority of the stocks' gains had already occurred / were priced in. Moderna saw shareholder returns of about 2,000% before its inclusion in the S&P 500, but 'only' returns of 19% afterwards. These are still outstanding results, but S&P 500 investors were a bit late to the party.
Due to the above, VTI has outperformed the S&P 500 since Moderna's IPO. It is a small difference, but a difference nonetheless.
VTI's strong, market-beating returns are a significant benefit for the fund and its shareholders, and a core part of the fund's investment thesis.
Notwithstanding the above, I do think it is important to note that VTI does not consistently outperform the S&P 500. Sustained periods of matching performance are quite common, as are periods of (usually low) underperformance. As an example, VTI has matched the performance of the S&P 500 these past ten years.
VTI's diversified holdings and strong market-beating returns are the fund's two key benefits, but the fund has other smaller advantages too. Let's have a look at these.
Low Expenses
VTI offers investors exposure to thousands of stocks at a very low price. VTI sports an expense ratio of just 0.03%, functionally equivalent to zero. The fund's expenses are moderately lower than average too, with the average equity ETF sporting a 0.28% expense ratio, as per Vanguard data.
Lower expenses directly increase (or reduce by less) shareholder returns, and are a benefit for the fund and its shareholders. Lower expenses are also one of the only surefire ways for investors to boost returns. Alpha can fail to materialize and leverage is risky, but lower expenses are always beneficial.
VTI Share Price - Competitive Valuation
VTI's valuation is a little bit more competitive than that of the S&P 500. This could lead to small capital gains for the fund and its shareholders, assuming valuations normalize. As the difference in valuation is quite small, this is a minor benefit, but a benefit nonetheless.
(Source: Vanguard Corporate Website)
Vanguard's Corporate Structure
Long-time readers know Vanguard is my top index fund provider. This is due to the company's unique corporate structure. Vanguard is organized as a mutual company, and is owned by its own customers, and it has no external investors or shareholders. No shareholders means no profits, which lowers costs for customers. It also ensures no conflict of interest between Vanguard's owners and its customers, which are one and the same. The structure makes for a sleepy, low-cost company: perfect for index funds.
Vanguard's structure mostly precludes the possibility of price gouging and shareholder-unfriendly actions and motives, as these won't, and can't, benefit anyone.
VTI offers investors several important benefits and positives, but the fund has its fair share of risks and drawbacks too. Let's have a look at these.
VTI - Risks and Drawbacks
Comparatively Risky Holdings
VTI's holdings have a broadly average level of risk, this is a diversified equity index after all.
VTI's holdings are, however, slightly riskier than those of most large-cap equity indexes, including the S&P 500. As mentioned previously, VTI invests in U.S. equities of all sizes, including mid, small, and micro capitalization companies. Smaller companies tend to have weaker balance sheets, less resilient business models, and undiversified revenue streams compared to their larger peers. Smaller companies also generally lack the financial and operational capacity to withstand recessions and downturns, at least without significant financial losses. As such, smaller companies tend to significantly underperform during downturns and recessions. VTI invests a small portion of its value in smaller companies, the S&P 500 does not, and so the fund slightly underperforms during downturns and recessions. This was last the case during 1Q2020, the onset of the coronavirus pandemic.
Notwithstanding the above, I would like to say that it is plausible for smaller companies to outperform during recessions and downturns. Underperformance is likely, but not a given, and one can easily imagine a recession centered on larger companies.
Valuation
VTI seems slightly undervalued on a relative basis, as shown a few sections ago, but also slightly overvalued on a historical basis. This is simply because, as per data from J.P. Morgan, all relevant U.S. equity subclassifications are overvalued on a historical basis. Stocks of all sizes and market capitalizations seem overvalued, as are value stocks themselves. Investors don't have many options when even value is overvalued.
(Source: JPMorgan)
VTI seems slightly overvalued on a historical basis, but slightly undervalued on a relative basis. On net, the fund seems reasonably valued, which is about as best as one can hope for under current market conditions.
VTI - Other Considerations
So far, I've focused on VTI's benefits and drawbacks. There are other considerations that don't fit into either, but which are important nonetheless. Let's have a look at these.
Dividend
VTI's total shareholder returns are quite strong, but the fund's dividend yield and dividend growth are about average for an equity index fund.
VTI yields 1.20%, a tiny bit less than the S&P 500.
VTI's dividend growth figures are stronger, but not that great either. The fund's dividend tends to grow, and has grown at a 8.8% CAGR for the past ten years or so.
(Source: Seeking Alpha)
VTI's dividend growth figures are comparable to those of the S&P 500.
(Source: Seeking Alpha)
VTI's dividend growth figures are strong enough that the fund's investors should see steadily increasing income figures. Yields on cost are reasonably good, but not fantastic, with VTI having a 10 year yield on cost of about 4.6%.
(Source: Seeking Alpha)
VTI's dividend yield and dividend growth are not bad per se, but they are also definitely not that great. The fund offers investors many important benefits and a solid investment thesis, but not strong dividend or dividend growth.
As such, the fund seems like a less appropriate choice dividend investors, especially income investors and retirees who depend on strong dividends to fund their retirements.
No International Diversification
As a final point, VTI invests in U.S. equities exclusively, and lacks international exposure. Due to the strength, dynamism, and performance of the U.S. economy and equity markets, I don't think international diversification is necessary, but it would definitely be ideal. Consider pairing VTI with an international or global fund. The Vanguard Total International Stock ETF (VXUS) is the obvious choice, but there are lots of options in this space.
As mentioned previously, VTI's comparatively low dividend yield and lack of international diversification are not negatives per se, but are still important characteristics of the fund which investors need to consider.
Is VTI A Buy, Sell, Or Hold?
VTI's diversified holdings and strong market-beating returns make the fund a fantastic long-term investment, and a buy.
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