Todd Rosenbluth is director of ETF and mutual fund research at CFRA.
When an elephant prepares to take steps in the jungle, the other animals should take notice. Such an analogy is appropriate with Vanguard and the ETF market.
The average Vanguard ETF product has $10 billion in assets under management, and the firm gathered $50 billion in assets through the first four months of 2017, second only to industry heavyweight iShares' $78 billion, according to FactSet data.
Unlike some ETF providers, Vanguard has been more prudent in expanding its product lineup, with just three new offerings since the beginning of 2014, and 70 in total. Yet in late May, Vanguard updated its regulatory filings to potentially launch transparent, actively managed ETFs. We at CFRA see this as the firm providing additional insight to regulators ahead of hopeful approval.
Given the firm's success in managing active strategies and its ability to retain and grow assets despite competitive pressure from passive products, CFRA thinks Vanguard will have continued success with such future iterations. However, our crystal ball on possible timing is much cloudier.
Source: CFRA’s MarketScope Advisor, May 26, 2017
Opaque Daily Holdings
Yet unlike the SPDR S&P 500 ETF Trust (SPY), the iShares Core S&P 500 ETF (IVV) and the iShares MSCI EAFE (EFA)—three of the top five ETFs by assets—Vanguard does not provide daily transparency of its holdings because the ETFs are share classes of a portfolio that includes mutual funds.
For example, on Vanguard's website, VOO's information technology weighting was 22.5% as of April 2017, while iShares’ IVV has 23.1% as of May 26, despite tracking the same index.
To protect shareholders from some of the transparency risks, CFRA thinks Vanguard could launch a quantitative active equity approach, similar in style to the mutual fund Vanguard Strategic Equity Income Fund (VSEQX).
For this existing fund, Vanguard's quant group relies on a computer-driven stock selection process to build a portfolio with a similar risk profile to an MSCI small/midcap blended index, while seeking to generate better returns.
Attractive Stock Traits
According to the fund's annual report, management believes that attractive stocks exhibit healthy balance sheets and steady cash flow generation; sound investment policies that favor internal over external funding; consistent earnings growth; strong market sentiment; and reasonable valuation.
Regular ETF.com readers will recognize some of these attributes as consistent with the general philosophy many asset managers—including Franklin Templeton, Goldman Sachs and John Hancock—have communicated with their multifactor ETFs. However, CFRA thinks Vanguard will keep management's discretion on whether to buy or sell a stock, rather than creating an index to track that could be potentially front-run.
Relative to its Lipper midcap core peer group, VSEQX is in the top quartile on a one-, three- and five-year total return basis.
The approximately 400 stocks are well-diversified on a sector basis to technology (16% of assets), financials (16%), consumer discretionary (15%) and industrials (15%). VSEQX has a 0.18% expense ratio, well below its 1.1% mutual fund peer group and cheaper than many index-based ETFs.
Another option would be to offer an ETF version of the Vanguard Global Minimum Volatility Fund (VMVFX), an active strategy that launched at the end of 2013. In building the portfolio, Vanguard's quant group evaluates a variety of factors they think drive a stock's volatility.
These fundamental drivers include risk factors such as growth, value, dividend yields, size, volatility and liquidity. In addition, the portfolio construction process includes estimates of each stock's correlation, according to the fund's annual report.
While investors should not rely solely on a three-year track record, VMVFX's one-year total return as of May 26 was stronger than passively managed iShares Edge MSCI Minimum Volatility Global (ACWV). VMVFX has a 0.25% net expense ratio, higher than ACWV's 0.20%.
While both funds have approximately half their assets in the U.S., ACWV has more exposure to Japan, while VMVFX has a 6% weighting to Canada, a country that is not part of ACWV. Both funds, ranked independently by CFRA due to their different fund structures, are viewed favorably for the low-risk holdings inside.
Vanguard Launches Draw A Crowd
When Vanguard has launched ETF products in the recent past, it has had success in gathering assets.
For example, the Vanguard Tax-Exempt Bond Fund ETF (VTEB) came to market in August 2015 and already has $1.2 billion in assets. CFRA ranks the index-based investment-grade municipal bond product, which has a favorably low 0.09% expense ratio, cheaper than alternatives. The iShares National Muni Bond (MUB), the SPDR Nuveen Bloomberg Barclays Municipal Bond ETF (TFI) and the VanEck Vectors AMT-Free Municipal Index ETF (ITM) all have more than $1 billion in assets, but only recently have faced competition from Vanguard.
Also launched in the first quarter of 2016 were the Vanguard International High Dividend Yield ETF (VYMI) and the Vanguard International Dividend Appreciation ETF (VIGI), which, combined, already have approximately $700 million in assets. VYMI has a 0.32% expense ratio, while VIGI costs 25 basis points.
Investors should look beyond a likely low expense ratio for a new product to understand what's inside and whether that makes a prudent investment. However, potential launches by a patient industry leader such as Vanguard are likely to draw interest. How the industry responds could affect relative standings in the ETF jungle.
At the time of writing, neither the author nor his firm held any of the securities mentioned. Todd Rosenbluth is director of ETF and mutual fund research at CFRA, an independent research firm that acquired S&P Global Market Intelligence's equity and fund business in October 2016. He can be reached at firstname.lastname@example.org. Follow him at @ToddCFRA.
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