A Rising Ship
Readers of this site are, generally, a breed of investor a bit more discerning than the average–after all, taking time to research individual stock selections isn’t for the faint of heart, and some would just as soon throw a dart at a wall to pick a stock than read a quarterly report. For those dart-throwing folks, finding a handful of all-weather ETFs or mutual funds is generally the preferred investment strategy. While the individual stock-picking crowd has, in our experience, a general tendency to look down on ETFs as almost some form of investment cheating, we believe that there is a place in everyone’s portfolio for an ETF or two when ideas or scarce or one’s conviction about a broader sector or market is bullish overall.
As they say, a rising tide lifts all boats, and today we dive into an ETF that is premier boat-lifter, the massive Vanguard Total Stock Market ETF (NYSEARCA:VTI), hereon referred to as VTI. Let’s dive in.
Structure
To say that VTI is massive would be an understatement–as of this writing the fund currently holds $1.5 trillion (yes, with a T), net assets. While quarterly fund flows are down a bit since spiking in 2020, they are still elevated above historic norms, with VTI adding $6 billion to its assets in the latest reporting quarter.
The fund takes, as the name implies, a total market approach, and thus its benchmark is the CRSP U.S. Total Market Index. In practice, however, the fund skews more toward large cap holdings, resulting in a return profile that looks not all that different from the S&P 500 (SPY):
As can be seen, the fund has moved more or less in lockstep with SPY, with a slight bit of divergence appearing over the last year or two. This is because the fund is a weighted index, and it broadly mirrors the CSRP, which itself has a median holding market cap of $150 billion.
As you would expect from a total market strategy, VTI (like CSRP), invests in a lot of stocks. As of this writing the fund held 3,719 stocks (the CSRP holds3,648), but as with many other weighted funds, large and mega-cap stocks comprise an outsize portion of holdings and, therefore, returns.
As can be seen by the scatterplot above, the fund’s largest holdings are in Microsoft (MSFT), Apple (AAPL), Nvidia (NVDA), Amazon (AMZN), and Google (GOOGL), to name a few, while the vast, vast majority of holdings sit below the 0.05% mark in terms of AUM.
What this means in practice is that 28% of the fund’s assets are invested in its top 10 holdings, which, subsequently, makes the fund a bit more vulnerable (or well-positioned) for big swings in the price of its top 10 holdings. On the flip side, large gains in, say, small cap stocks–the fund’s investment in Merrimack Pharmaceuticals (MACK), for example, has garnered an incredible 60,000% return–make little impact to the overall fund.
This is not a knock on VTI, it’s simply the way the fund is structured. In order to mirror a benchmark, funds necessarily adopt the investment philosophies of said benchmark.
Fees
In keeping with Vanguard’s tradition of being low-cost, VTI is incredibly inexpensive to own. With management fees of 0.02% and zero 12b-1 fees, the total expense to own the fund as of this writing comes out to 0.03% annually.
As the above chart shows, total fee expense per year for a $10,000 initial investment in VTI assuming a 5% average return each year would amount to $39 per year after 10 years.
Who Is This Fund For?
Like any other ETF, we think VTI should be viewed as a tool for investors to achieve a specific end. In this case, we think that investors could turn to VTI when they feel a broad conviction about the general market or economy, and wish to express that opinion through a large basket of stocks. Conversely, those with a dim view on the broader global and U.S. economic outlook would probably do well to look elsewhere.
Those interested in VTI will be happy to know that its valuations also currently trade at the mid-range of historic levels.
With a current forward price to earnings of 21x and an EV/EBITDA of 14.8x, VIT currently sits a little above the 10-year valuation average of 19.1x and 12.9x, respectively. We do not find this to be a cause for alarm–in fact, we see valuations are relatively reasonable.
After the Fed’s interest rate hikes let some air out of the valuation balloon throughout 2021 and into 2022, so to speak, we appear to be approaching a more normalized level of valuation, one that we think could expand once more when the Fed decides that it’s time to trim rates down (though, of course, we cannot be sure of when that day will come, or if it even will).
Risks
Principal risks to this fund are overall market risk (which, we hope, should be obvious), as well as indexing risk. Indexing risk is the risk investors bear for fluctuations in the index’s NAV to share price if the market dislocates when it’s time to re-balance. For example, if the fund needs to sell a large amount of Microsoft to reflect the large drop in the underlying security, buyers may not be available causing the hit to the fund to be greater than the loss in the underlying security itself. Overall, however, we assess this risk to be relatively low.
An additional risk (which is baked into the investment philosophy of VTI) is concentration risk. Any time you expose 28% of your portfolio to 10 holdings, you are at risk for outsized volatility should those top holdings experience big swings.
The Bottom Line
VTI is a well-constructed, inexpensive fund to own. We think that investors who are looking for total market exposure and who believe the long-term outlook for the global and U.S. economy to be bright will find VTI to be a compelling prospect for a portion of their portfolio. As stated at the beginning of this article, a rising tide lifts all boats, and, while the converse is always true, we think VTI’s tide should continue to rise over the long term.
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