Vanguard’s Active ETFs Underperform

September 30, 2020

More than two years ago, Vanguard rolled out a group of six actively managed ETFs targeting factor strategies. The move was almost shocking, as the company’s founder basically pioneered passive investing.

Despite John Bogle advocating for cap-weighted indexing as a strategy for more than 40 years, Vanguard is actually a strong player in the active management space, with 70 out of its 132 different mutual funds implementing active strategies.

Although the issuer qualifies as a major participant in the active mutual fund space, its active ETFs have languished in terms of both assets and performance compared to the rest of Vanguard’s offering. They remain the smallest funds in its family of 80 ETFs in terms of assets under management (AUM).

Seventeen of the funds in Vanguard’s ETF lineup have less than $1 billion in AUM. The six factor funds range in size from just $37 million to $134 million, which—let’s be honest—is chump change for an issuer like Vanguard.

We compared these six active ETFs in performance with the dominant passive ETF for each category over a two-year period. Our results showed the Vanguard funds lagging in each case.

We used the iShares single-factor ETFs and Goldman Sachs’ multifactor ETF, because those were the largest funds in their respective categories.

We also used the ETF.com comparison tool to look at the differences in addition to performance data from Bloomberg covering the two-year period ended Sept. 29, 2020. Keep in mind that while Vanguard’s passive ETFs disclose their holdings monthly, their active ETFs disclose holdings daily.

Multifactor

The Vanguard U.S. Multifactor ETF (VFMF) seems most comparable to the nearly $10 billion multifactor Goldman Sachs ActiveBeta U.S. Large Cap Equity ETF (GSLC), the largest multifactor ETF. Both funds target the value, momentum, quality and low volatility factors.

VFMF has an expense ratio of 0.19%, while GSLC charges 0.09%. And VFMF has 572 holdings versus 435 for GSLC, and both share three of their top 10 components in common. Technology is the biggest sector for both funds, weighted at 23.73% for VFMF and 33.34% for GSLC.

Based on the MSCI analytics, VFMF has significant overexposure to the low size factor at 1.17 and the value factor at 0.45. Meanwhile, GSLC’s largest factor loadings are momentum at 0.27 and quality at 0.19.

That technology weighting may be the key point of differentiation, as during the two years ended Sept. 23, the performance of the two funds diverges by roughly 30 percentage points in favor of GSLC. The sector has outstripped the other sectors in the S&P 500.

 

 

View how VFMF stacks up against GSLC in our ETF comparison tool.

 

Quality

The $47 million Vanguard U.S. Quality Factor ETF (VFQY) targets securities with strong fundamentals in order to capture the performance of the quality factor. The largest passively managed quality-focused ETF is the $19 billion iShares MSCI USA Quality Factor ETF (QUAL). QUAL is actually the more expensive of the two, despite being an index fund, charging 0.15% to VFQY’s 0.13%.

The two funds have only one stock in common in their top 10 holdings—Apple. Again, technology is the largest holding for both, but while it’s a quarter of the total weight of VFQY, the sector represents more than 36% of the weight of QUAL.

The iShares ETF also has far more exposure to the quality factor, based on MSCI data, with a quality score of 0.46 versus 0.27 for VFQY. Interestingly, VFQY’s largest factor exposure is the low size factor at 1.23.

It seems like the sector disparity is again driving the difference in performance, which is nearly 18 percentage points in favor of QUAL.

 

 

View how VFQY stacks up against QUAL in our ETF comparison tool.

Value

With $118 million in assets, the Vanguard U.S. Value Factor ETF (VFVA) is the largest of the funds in the Vanguard factor ETF family, and has a counterpart in the $6.7 billion iShares MSCI USA Value Factor ETF (VLUE). VFVA is cheaper than index-based VLUE, charging 0.14% to VLUE’s 0.15%.

VLUE is a much more concentrated portfolio, with 151 holdings, while VFVA has a whopping 756 components. The funds share five of the same companies in their top 10 holdings. Financials is VFVA’s largest sector, with a weighting of 28.24%, while technology, not even in VFVA’s top three sectors, is the largest sector for VLUE at 25% of the portfolio.

VFVA actually has a higher exposure to the value factor than VLUE, 0.98 vs. 0.84. However, VFVA’s largest factor loading is low size, at 1.43.

VFVA trails VLUE by more than 8 percentage points at the end of the two-year period.

 

 

View how VFVA stacks up against VLUE in our ETF comparison tool.

Momentum

The $60 million Vanguard U.S. Momentum Factor ETF (VFMO) has a counterpart in the nearly $12 billion iShares MSCI USA Momentum Factor ETF (MTUM). Again, the iShares fund is more expensive, costing 2 basis points more than the Vanguard fund, at 0.15%.

VFMO has the larger portfolio, with 661 holdings versus 127 for MTUM. Although both funds have Tesla as their largest holding, VFMO weights it at 1.88%, while MTUM has it weighted at 6.53%—a significant difference. In all, the funds have four securities in their top 10 holdings in common.

(Use our stock finder tool to find an ETF’s allocation to a certain stock.)

Technology is again the largest sector for both, but the weighting difference is not as stark. Technology stocks represent nearly 32% of VFMO’s portfolio and nearly 41% of that of MTUM. Momentum is the largest factor exposure for MTUM, at 0.85, while for VFMO, it is 0.71, with low size for the Vanguard fund having a loading of 1.02.

The performance differential between the two at the end of the two-year period was nearly 15 percentage points, with VFMO trailing MTUM.

 

 

View how VFMO stacks up against MTUM in our ETF comparison tool. 

Volatility

The $73 million Vanguard U.S. Minimum Volatility ETF (VFMV) relies on a proprietary model that considers different types of risk rather than just screening for low volatility. Its index-based counterpart is the $34 billion iShares MSCI USA Min Vol Factor ETF (USMV). The Vanguard fund has an expense ratio of 0.13%, while the iShares fund charges 0.15%.

VFMV has the smallest number of holdings of the Vanguard factor ETFs, with just 127 securities, while USMV has 196. Their top 10 holdings have just two companies, Verizon Communications and Merck, in common. Technology is the top sector for both funds, and in a deviation, the Vanguard ETF has the higher weighting for the sector, at nearly 29% versus 18% for the iShares ETF.

In terms of factor exposures, neither fund has low volatility as its strongest factor exposure. VFMV has a low size exposure of 1.07 and a low volatility exposure of 0.39. Meanwhile, USMV’s greatest factor exposure is to yield, at 0.26 and low volatility, at 0.11.

At the end of the two-year period, nearly 15 percentage points separated the funds’ performance results.

 

 

View how VFMV stacks up against USMV in our ETF comparison tool. 

Size/Liquidity
Vanguard has rejected the idea that size qualifies as a factor, arguing that illiquidity is the cause of outperformance rather than small size. With that in mind, we compare the $36 million Vanguard U.S. Liquidity Factor ETF (VFLQ) with the $696 million iShares MSCI USA Size Factor ETF (SIZE). The iShares fund is 1 basis point more in expense ratio than the actively managed Vanguard fund, which charges 0.14%.

Portfolio size is less of an issue with these two funds. SIZE has 620 holdings to VFLQ’s 779. They do not have any of their top 10 holdings in common, and neither has technology as its largest sector.

Instead, both have financials as their largest sector, with VFLQ weighting it at 32.8% and SIZE weighting it at 21%. That said, SIZE has technology as its second-largest sector, while it is the fourth-largest sector in VFLQ.

In terms of factor exposure, VFLQ has the higher exposure to low size, despite its focus being on the liquidity factor, with an exposure of 1.66, while SIZE has an exposure to the same factor of 0.61.

Technology exposure and small-size exposure appear to be the drivers of the funds’ performance difference at the end of the two-year period, with VFLQ trailing SIZE by 15 percentage points.

 

Charts courtesy of StockCharts.com

 

View how VFLQ stacks up against SIZE in our ETF comparison tool. 

Final Thoughts

Vanguard is known for its passive investments, but it is no slouch in the active management department, with a full array of actively managed mutual funds. The fact that its actively managed ETFs underperform similar passively managed funds so significantly is surprising.

However, in most cases, the Vanguard ETFs are underweight in the technology sector, which has outperformed significantly in recent years. Similarly, many of the Vanguard funds have strong exposures to the low size factor, and small caps have been underperforming recently.

Heather Bell can be reached at [email protected]

 

 

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