Morningstar Magazine - October/November 2017 - 68

Strategies

Value Giants
This ETF is a good way to own cheap
mega-caps.

BEST IDEAS: PASSIVE

Alex Bryan

This article is adapted from the ETF's Morningstar
Global Fund Report dated July 17, 2017.
Vanguard Mega Cap Value ETF MGV offers
low-cost exposure to the largest U.S. value stocks.
While it isn't quite as well diversified as broader
large-cap value index funds, its market-capweighted portfolio accurately represents its target
market segment and promotes low turnover.
The fund's considerable cost advantage further
supports its Morningstar Analyst Rating of Silver.
The fund targets stocks representing the cheaper
and slower-growing half of the U.S. megacap market (which covers the largest 70% of the
market) and weights them by market capitalization. This gives the fund a larger market-cap
orientation than most of its large-value
Morningstar Category peers. In fact, the average
market capitalization of its holdings is about
twice the corresponding figure for the category.
The portfolio tilts toward mature giants
such as Microsoft MSFT, Exxon Mobil XOM, and
JPMorgan Chase JPM. These holdings may
offer lower expected returns than their smaller
counterparts, but they are also less risky.
The fund's holdings tend to have less-attractive
business prospects than their growth counterparts, so they are not necessarily bargains.
But they could become undervalued if investors
become overly pessimistic about these
firms' outlooks. Potential mispricing here will likely
be smaller than it could be further down
the market-cap ladder because more analysts
follow these stocks.

68

Morningstar October/November 2017

the Russell 1000 Growth Index by 1 percentage
point annualized. This outperformance has
not been consistent. Over the past decade, the
Russell 1000 Value Index lagged its growth
counterpart by 3.4 percentage points annualized.
While they won't always come out ahead,
value stocks should offer a modest return edge
over the long term.

Because the fund covers approximately half
the mega-cap market, it includes some stocks with
modest value characteristics. However, these
holdings help temper volatility. The fund has less
overlap with its growth counterpart than
rival mega-cap value and growth funds based
on the Russell Top 200 Index. Its benchmark
applies generous buffering rules to limit
unnecessary turnover and transaction costs, which
could permit modest style drift. The portfolio's
value characteristics are similar to the
category average, but its larger market-cap tilt
could influence its relative performance.
Low fees have helped the fund outperform
its peers. From its inception in December 2007
through June 2017, the fund beat the
large-value category average by 59 basis points
annualized, with comparable volatility.
Fundamental View

Value stocks have a good long-term record in most
markets studied. From December 1978 through
June 2017, the Russell 1000 Value Index outpaced

Investors may demand higher expected returns
to own value stocks, which have less-attractive
business prospects than growth counterparts and
could be riskier. Value stocks tend to be less
profitable and grow more slowly, and are less likely
to enjoy sustainable competitive advantages.
Not surprisingly, the fund's holdings usually
generate lower average returns on invested capital
than those in Vanguard Mega Cap Growth
ETF MGK. That said, most are profitable. At the
end of May, about 96% of the portfolio was in firms
with positive net income over the previous
12 months.
Although these stocks often trade at low valuations
for good reason, they could become undervalued
if investors extrapolate past growth-or lack
thereof-too far into the future. However, because
most mega-cap value stocks are more widely
owned and have more equity analyst coverage
than their smaller counterparts, the market
is less likely to significantly misprice them. The
return advantage from tilting toward value stocks
has historically been more pronounced
among smaller-cap stocks, but the fund's megacap holdings tend to be less risky.

Vanguard Mega Cap Value ETF MGV
Growth of $10K 08/31/2017

Vanguard Mega Cap Value ETF

Stats 08/31/2017

12.72

14K
$

12.25 12

Morningstar US
Large Val TR USD

09/2014

09/2015

09/2016

10
8

Morningstar Category

Large Value

Inception Date

12/17/2007

Morningstar Analyst Rating

*

Expense Ratio (%)

0.07

5-Yr. Total Annual Return (%)

13.79

5-Yr. Total Rtn Category % Rank 14



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