The Vanguard Mega Cap Value ETF (NYSEARCA:MGV) is an exchange-traded fund of shares from the giant asset manager Vanguard. The fund has more than $6 billion in assets under management and aims to track performance a benchmark index that measures the investment performance of the largest-cap value stocks in the United States. The respective index is CRSP US Mega Cap Value Index, which provides diversified exposure to the largest value stocks in the US market.
2023 was the year of tech mega-caps, with sister fund Vanguard Mega Cap Index Fund (MGC) up more than 28%. MGC is the expression of large-growth mega-caps and has been propelled by the exceptional performance of the ‘Magnificent 7‘. MGV, on the other hand, had a a more moderate performance, up only 6.7% this year. Technology has eclipsed all other investments this year, but we think 2024 will be different, with the baton passing to value stocks.
What goes up must come down
There is no doubt that artificial intelligence will change many aspects of our lives and help big tech companies generate profits, but nothing can stay overvalued for too long:
Over long periods of time, we always get a reversion to the mean. The steeper the climb, the harder the fall. Tech is at an all-time high relative to the S&P 500, and if history is any lesson, it’s that the future usually means the past. Have no doubt, the chart above will mean a step backwards in the years to come. We believe tech valuations are extremely high and expectations are high thanks to extremely high P/E ratios:
Even though in an optimistic scenario, tech mega-caps will not collapse, they will still fail to provide the same high returns in the future.
High value companies are cheap
MGV falls into the Large Cap Value Morningstar category:
The median market cap of ETF holdings is $136 billion, with an earnings growth rate of 13.8%:
The “Value” box in the Morningstar universe refers to companies that exhibit more moderate or weaker growth relative to the multiples presented by the “Growth” box. MGC’s earnings growth rate is 19% for comparison.
Unlike tech mega-caps which have P/E ratios in the 20s and 30s (some even higher), value mega-caps expose cheap entry points via a 15.7x P/E ratio . Entry points matter, and even if an asset is not as attractive as a growth stock. Buying low valuation stocks guarantees multiple expansion during a bull market. Remember the old adage “buy low, sell high”? We are of the view that buying large-cap value stocks here represents the “buy cheap” part of the respective phrase, while selling overvalued mega-cap tech stocks is the “selling low” aspect of the respective phrase. a high price.”
Higher interest rate environment favors large caps
It takes time for higher interest rates to trickle down to corporate balance sheets, but they do trickle down eventually. They result in a higher financing cost for corporate debt, as well as a higher opportunity cost for their projects. Initiatives that looked attractive from an IRR perspective at 0% rates are quite different at 5% risk-free rates. Higher rates lead to lower profitability for a company, all else equal. However, nothing is that simple and the balance sheet profile of a company is very different from one case to another, even if not all sectors are equal.
Large-cap companies are best positioned for the current environment, with investment grade rating profiles and term debt maturity profiles. In contrast, small and mid-cap companies experienced significant difficulties. apprehensions:
Small-cap stocks tend to feel the impact of interest rate changes more than their large-cap counterparts. Not only do small-cap companies rely more on short-term financing to survive, but they also tend to rely more on floating-rate debt, thereby enhancing the immediate impact of any increase in interest rates on their profits.
Ultimately, small caps should outperform, but that’s not the time yet. For this to happen, we need to see a systemic and permanent decline in the cost of funds. We expect this to be the case in 2025 and beyond. Next year, federal funds will remain elevated relative to historic levels. This leaves us in the cheap large cap camp, a sector that will offer an attractive risk/reward ratio through 2024.
- Assets under management: $6.3 billion.
- Sharpe ratio: 0.57 (3 years).
- Standard. Difference: 15.2 (3 years).
- Yield: 2.5%.
- Bonus/Discount on NAV: 0%.
- Z-Stat: n/a.
- Leverage ratio: 0%.
- Effective duration: n/a
- Expense ratio: 0.07%
- Composition: US Large Cap Stocks – Value
MGV is a fund that shows very solid long-term results:
Given its composition, the ETF underperforms during periods of market exuberance, but excels during normalized economic cycles and market sell-offs. The fund was down just -1.23% during a brutal 2022, while it posted an outsized showing in 2019 when the Fed began cutting rates after its latest round of monetary tightening.
We expect the Fed to begin reducing its Fed Funds in mid-2024 and for MGV to benefit from its robust fundamentals in 2024 and 2025, with a very attractive valuation starting point.
The fund’s long-term annualized performance also stands out, with the vehicle posting 5- and 10-year returns above 10%:
The fund’s historical performance gives us the picture of a buy-and-hold vehicle, where retail investors are best served by finding attractive valuation entry points and then holding on to the investment. We believe the current environment provides this opportunity.
MGV is an equity ETF. The vehicle focuses on large-cap value companies and has only posted a modest price return of 6.7% in 2023. We believe we will see a shift in 2024, with mega- technological capitalizations passing the baton to value large-cap stocks. , with technologies presenting extremely extensive valorization measures. MGV, on the other hand, has a low P/E ratio of just 15.7x and highlights the strong balance sheet and financing profiles of large conglomerates. Rising rates will also be a theme of 2024 in a historical context, and we believe large caps are still set to outperform in this high interest rate environment. We like MGV for its constituents, stable funding profiles, and low valuation entry point, and believe capital will move from growth to value in the new year.