VO: Mid All Over (NYSEARCA:VO)

Mid-cap and the Vanguard Mid-Cap ETF (NYSEARCA: VO) had a performance in 2024 that can only be described as middling. Returns are better than small caps ( VB ) but lag behind the S&P 500 ( SPY ) and significantly behind megacaps ( MGC ).

However, that changed recently and VO leads the pack in H2. This article looks at why and whether it can be expected to last.

Introducing VO

VO is a passively managed fund that seeks to track the CRSP US Mid Cap Index, which measures the investment performance of mid-cap stocks.

There isn’t much literature on how the underlying index is composed, and the CRSP website only states that “Targets US companies in the top 70%-85% of investable market capitalization.”

This chart is from the July CRSP report showing the market caps involved.

The CRSP US Mid Cap Index is one of four mid-cap indices summarized below.

There are only subtle differences, but it seems that the smaller amount of holdings and the resulting higher concentration in the top 10 leads to a slight outperformance; a positive for VO. The fund also has a higher weighting in technology, when the industry is typically the top sector in the mid-cap.

The Schwab US Mid-Cap ETF ( SCHM ), for example, has a 15% weighting in technology and nearly 20% in industrials.

VO has a very low expense ratio of 0.04%, which is matched by SCHM, although its total returns lag over the 1-year and 5-year periods.

With high AUM of $171 billion, low expense ratio and solid performance, VO is one of the top funds in the mid-cap space. It’s also interesting because fund sponsor Vanguard has comparable funds in the small-cap and mega-cap space. It even has an S&P 500 proxy, the Vanguard S&P 500 ETF (VOO). This allows for easy comparison of funds and helps in the search for alpha.

Rare performance

VO has underperformed the broader market for a long time, with brief periods of relative strength. This is clear on a VO/VOO chart that is trending strongly lower. However, it is worth noting that the current increase is the largest since 2020-21.

VO/MGC shows that VO is also outperforming megacaps in recent months.

As encouraging as this is, the relative strength comes more from weakness in VOO and MGC rather than anything impressive in VO. Megacap stocks like Nvidia ( NVDA ) and sectors like tech are getting some much-needed rest to compress multiples. MGC has a PE ratio of 27.9, while VOO stands at 26.6.

VO is more attractive at 22.6, but its earnings growth rate is only 13.8% compared to MGC’s 18.5%. In other words, its multiple is lower for a good reason, and hardly a major reason to dump MGC to buy VO.

Earnings growth of 13.8% is solid enough, but VO is up nearly 40% from its October 2023 low, and there doesn’t appear to be potential for much more. This can be seen on the VO chart – it hit a new high in 2024 on August 30, but fell again and the rally in March was a case of two steps forward and one step back.

VO may hold up better than VOO and MGC during this correction period, but is not likely to consistently outperform unless the strength of the technology reverses completely. Given the long-term trend and strong earnings, this does not seem likely.

Favored by rotation

Some tailwinds for VO have come from rotations over the past month. Real estate was one of the best performing sectors and has a share of 7.68% in VO and only 1.1% in MGC.

Indeed, mid-caps have the largest REIT weighting of all market cap indices. It also has a lot more exposure to utilities.

The outlook for rate cuts is positive, particularly for rate-sensitive REITs and debt-laden utilities, but since the cuts are partly in response to a weaker economy and not just in response to lower inflation, the positive effects could be largely balanced. in other sectors. While it is too early to call a recession, there are clear signs of a slowing economy and labor market data is a concern. This is not the ideal background for VO with its high industry exposure.

In short, sector exposure has been positive in recent months, but you should be confident that the tech outperformance will be eclipsed by industrials, REITs and utilities to favor VO over VOO or MGC over the long term.

risks

Mid-caps carry more risk and this is highlighted on the fund page.

The concern is that the added risk does not lead to better returns. The table below (2015 data) shows that VO’s Sortino ratio is low and CAGR is in single digits compared to 13.58% for MGC,

Higher withdrawals and lower returns are a factor almost every year. It must be frustrating to maintain, and the divergence has widened further in 2023.

ConCluSIonS

VO is a decent fund in the midcap space. Its low expense ratio and returns are attractive. Additionally, its performance since early July also compares favorably to the broader market and megacap funds. However, I don’t think there is enough evidence to say that this is the start of sustained outperformance, and the historical data for VO is disappointing. Poor risk-adjusted returns have been a consistent feature over the past ten years, and this may continue.