VIOO: Small-Cap ETF With Good Risk-Adjusted Returns (NYSEARCA:VIOO)

WHOOO

According to Vanguard’s website, “Vanguard S&P Small-Cap 600 ETF (NYSEARCA: VIOO) seeks to track the investment performance of the S&P SmallCap 600 Index, an unmanaged benchmark representing small US companies. Using full replication, the portfolio holds all stocks in the same capitalization weight as the index”.

I think VIOO is a solid choice for those looking to add a small-cap tilt to their portfolio. In an environment surrounding large and overvalued tech markets, this ETF may fly under the radar. VIOO is highly diversified, has a historically good risk-adjusted return, a low expense ratio and a growing dividend yield to complement it. Historically, the dividend yield is at the top, along with top holdings representing lower PE ratios, which could mean one is buying VIOO at a value premium. I would think these are all great reasons to keep a well-diversified account.

Shiller PE

One thing that is worrisome with the current state of the market is that the total index is flooded with large-cap technology, resulting in an inflated “Price-Earnings” multiple. This can be visualized by looking at the current Shiller PE ratio chart.

It currently sits at 36.21, which is about 30-40% above its average of around 27. While this could mean the market is expecting a bullish rally, expected earnings are lower in markets with higher PE ratios . Fortunately, VIOO has many small caps that help lower the overall payout for wins.

Holdings

VIOO is extremely diverse. According to Seeking Alpha’s breakdown of holdings, they are spread across eleven different sectors, not including a small position in cash and equivalents. Their top 10 holdings represent no more than 6% of the total portfolio. This means they are not top-heavy like many weighted market indices, adding another level of diversification.

In terms of earnings payout for these companies, some of the top TTM PE holdings are lower than the overall index. For example, (MLI) is at 14-15 PE and (ATI) is around 23. A culmination of lower PE holdings means that VIOO’s dividend yield is at a reasonable level compared to historical values.

Obviously, 1.38% is not the highest it has experienced (which would indicate buy value), but it is historically high. This could mean that VIOO is not only a great index play, but also a value play at the current level.

Analysis

To analyze VSS, we compared the backtesting results of various other small-cap ETFs. These were SPDR® Portfolio S&P 600™ Small Cap ETF (SPSM), Shares ETF Vanguard Small-Cap Index Fund (VB), iShares Morningstar Small-Cap ETF (ISCB).

Since 2015, the results show that VIOO had a CAGR of 9.20%, which is the highest in the group. However, this came with a standard deviation of 20.62%, which is also the largest. So it is clear that VIOO has returned more, but it has come with a little more volatility. Risk reward is measured by the Sharpe Ratio, which is 0.45. It happens to be the second best, just behind VB, with a Sharpe of 0.46. The downside of this ETF is that it had the worst maximum drawdown measurement of 36.10%. This is about 3% lower than the next ETF in line.

VIOO resulted in the highest trailing value of $23,416 for a $10,000 investment since 2015. It’s pretty clear from the backtest that VIOO is the high-reward, high-risk version of the comparable small-cap ETF.

Expense report

The expense ratio is low for VIOO. It has 0.10% and is rated ‘A’ by Seeking Alpha. This is, of course, relative to other similar ETFs. This is slightly high compared to major index-tracking ETFs, but still a reasonable expense ratio.

Liquidity

I think liquidity is often looked at in terms of ETFs. The ability to move assets has somewhat of a value premium, and VIOO gets a good grade for it, according to the Seeking Alpha Dividend Scoreboard. Nearly $5 billion in assets under management (“AUM”) make it one of the largest and most liquid ETFs in its category.

dividends

While it has a risk-adjusted return, expense ratio and good liquidity, VIOO pays an annual dividend yield of 1.43%, with a 10-year compound annual growth rate (“CAGR”) of 13.22% . This is good enough to receive an ‘A’ dividend grade from Seeking Alpha’s scorecard.

Conclusion

Overall, VIOO is one of the “higher risk/reward” small-cap ETFs, but only by a small margin. I think the historically good risk-adjusted return, low expense ratio, and growing dividend yield are reasons to own this ETF in a well-diversified basket. The holding’s PE and dividend yield can also indicate that the investor is buying at a value premium.