S&P’s featured ETF of the month: Vanguard Growth Index Fund

This month’s Featured Fund of the Month is the Vanguard Growth Index Fund Ticker:(VUG), which carries Standard & Poor’s highest ETF ranking of “Overweight.” Based on an evaluation of the ETF’s holdings, Standard & Poor’s classifies VUG as an Equity-Large Cap Growth ETF. We believe it is important to assess a fund’s underlying holdings as part of analyzing various performance, risk, and cost considerations. S&P’s unique ranking methodology for equity ETFs incorporates all of these considerations in establishing ETF rankings.

SP U.S. Equity thinks that a growing number of financial advisors and investors are looking to ETFs as prospective portfolio selections. The investment appeal of ETFs typically includes their transparency, intraday liquidity, and relatively low costs.

In seeking out this month’s Featured ETF, S&P screened for equity ETF funds that scored positively for performance analytics, risk considerations, and cost factors.

We also looked for ETFs that had substantial size VUG recently had market capitalization of $4.1 billion), and considerable trading volume VUG was averaging about 396,000 shares a day). Also, in the evolving world of ETFs, VUG has been around for a while, having debuted in January 2004.

Like many of today’s equity ETFs, VUG is aimed at providing investment returns that are generally similar to those of the stocks in an equity index. In the case of VUG, Vanguard says that this ETF is designed to track the MSCI US Prime Market Growth Index. The ETF is expected hold all of the stocks in that index, with capitalization weightings approximating those of the index.

Recently, S&P’s holdings-based analysis of VUG produced generally favorable results. On the basis of both investment opinions from S&P equity analysts, as well as a quantitative Fair Value approach, S&P ranked VUG’s holdings favorably relative to a large universe of other equity ETFs. Also, S&P analysts had a “strong buy” or “buy” ranking on what were recently nine of VUG’s top 10 (largest) holdings, and a “hold” opinion on the tenth. This ETF was quite diversified, with about 420 holdings, and the top 10 stock holdings representing only 26% of the total, led by Microsoft Ticker:(MSFT) at about 4%, and Apple Ticker:(AAPL) at about 3%.

Recently, about 36% of VUG’s holdings were in the information technology sector. In early March 2010, S&P Equity Strategy raised its opinion on the information technology sector to overweight, from marketweight. The appeal of the overall sector reinforces S&P opinion on individual technology stocks owned by VUG.

With the prospect that a rising interest rate environment is ahead, S&P Equity Strategy points out that since 1946, the information technology sector increased the most of any sector in the 12 months following an initial interest rate hike by the Fed. The information technology sector’s outperformance during periods of interest rate tightening was seen as attributable to the sector’s balance sheet strength. This strength reduces the IT sector’s reliance on borrowing in a rising interest rate environment, thereby boosting its relative profitability. Also, S&P Equity Strategy thinks that pent up demand and potential for productivity increases through information technology capital expenditures improves the sector’s revenue visibility relative to other cyclical areas. In addition, S&P Equity Strategy thinks that the IT sector offers growth at a reasonable price.

However, VUG also offers some diversification across various sectors. health care and consumer discretionary accounted for 14% and 12%, respectively. VUG’s smallest sector representation was to telecom services and utilities, with each recently accounting for less than 1% of holdings.

In terms of industries, VUG’s largest weightings recently were to computer hardware (9.7%), systems software (7.3%), communications equipment (4.8%), Internet software & services (3.9%), and pharmaceuticals (3.9%). These top five sub-industries represented about 30% of total holdings. Both the sector and industry classifications used here are based on the Global Industry Classification Standard (GICS), which was developed by Standard & Poor’s and MSCI Barra.

Although some of the companies owned by VUG have a significant international presence, nearly all of the holdings (98%) are based in the United States. This includes a 79% allocation to large-cap U.S. equities.

Meanwhile, S&P Equity’s favorable overall ranking on VUG was helped by risk and cost profiles that were relatively favorable, when compared to those of other equity ETFs ranked by S&P. In the risk category, this included above-average rankings related to the S&P Quality Ranking (a measurement of historic growth and stability for earnings and dividends), and a relatively low standard deviation, which measures the volatility of the ETF’s price.

In the cost category, VUG had a favorable gross expense ratio (0.15%), while the bid/ask spread and the Price-to-NAV assessment were viewed as more neutral.

VUG recently had a dividend yield of 1.2%, and had provided a 12-month total return of about 70%, fueled by sharp appreciation in 2009. However, VUG was vulnerable to the sharp market sell-off between late 2007 and early 2009, which contributed to a five-year annual total return of about 3%.

S&P’s ETF analysis is a blend of quantitative and qualitative analysis that bubbles up to an Overall S&P ETF Ranking (Overweight, Marketweight, or Underweight) of an ETF security relative to our entire ETF universe. The underlying holdings of an ETF are evaluated based on analysis from S&P’s team of stock and fixed-income credit analysts, which operate independently of one another. S&P’s analytical elements for ETFs include three Performance Analytics that are all proprietary to S&P, including equity analyst STARS opinions on stocks of companies owned by ETFs. Overall, five of the 10 elements in S&P’s ETF ranking methodology are holdings-based, while the remaining five, including expense ratio, are tied to the ETF security itself.

As with all investments, S&P believes that investors should look to make selections that are suitable for their objectives and risk profiles.

For more access to Standard & Poor’s Equity Research go to www.GetMarketScope.com, or call 1-877-219-1247, or send an email to [email protected].

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S&P ETF Rankings reflect an analytical mix of assessments related to an ETF’s holdings and the ETF security itself. An S&P Overweight ETF is ranked in approximately the top quartile of equity ETFs on which S&P has an overall ranking. The S&P ETF Ranking is accurate as of March 15, 2010, but is subject to change at any time. For important disclosures, please go to www.standardandpoors.com, and click on “Regulatory Affairs.”

Related Topics: Featured Fund Of The Month