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The Vanguard Information Technology ETF (NYSE:VGT), with $22.9 billion in total asset under management, is one of the largest tech-focused, exchange-traded funds, yet still dwarfed by its larger competitor, the Invesco QQQ ETF (QQQ) with $71bn in total assets. While the two ETFs have a similar focus, we think VGT has some compelling advantages including a larger portfolio, including more exposure to small-caps and emerging companies in the sector. Impressively, VGT has outperformed QQQ in recent years which we note has been a particularly strong period for tech stock. We think VGT should outperform to the upside but may present higher in a potential down market which we discuss below. This article presents VGT and its characteristics along with our view on where the fund is headed next.
(Source: FinViz.com)
VGT ETF Background
There are some important differences in the construction methodology of VGT relative to QQQ. We use, QQQ as a comparison given it is the largest “tech” focused ETF and one of the most actively traded funds in the market. VGT with 333 holdings has a larger portfolio compared to the current 104 stocks in the “Nasdaq-100” ETF, with the main difference that it includes stocks that have a primary listing on the NYSE. It may come as surprise but traditional tech giants like International Business Machines (IBM) and Oracle Corp. (ORCL) are not NASDAQ stocks and thus not a component of QQQ.
On the other hand, VGT has some notable exclusions as it does not include Amazon.com (AMZN), Alphabet Inc. (GOOGL)(GOOG), and Facebook, Inc. (FB) which are among the most widely-held tech leaders. This is based on VGT tracking index which is the MSCI US Investable Market Information Technology 25/50 Index, and its unique methodology. The index features companies that “serve the electronics and computer industries or that manufacture products based on the latest applied science.” Looking at the actual fund prospectus, it does not include “internet information providers” as a sub-industry among its holdings. It’s an admittedly arbitrary classification and criteria but the point is for investors to have a clear understanding of what’s included in the ETF.
The table below presents the top 25 holdings for VGT as of July 31, 2019. The top two holdings are Apple Inc. (AAPL) and Microsoft Corp. (MSFT), each with a weighting of 15.6% and 15.4%, respectively, larger than the corresponding weight in QQQ. Credit service providers Visa Inc. (V) and Mastercard Inc. (MA) each with 4.5% and 3.9% weighting are not at all a part of QQQ. V and MA are some examples of companies that blur the line between financial services and tech, but considering the digitization of payments globally, have a strong case to be included in any tech investment portfolio.
VGT top 25 holdings. Source: data by YCharts/ table by author
The real value we see in VGT is the higher exposure to mid- and small-cap tech stocks which together represent 16.32% of the total fund compared to just 3.18% in QQQ. Going through the list of holdings in VGT, the exposure to emerging software companies like The Trade Desk, Inc. (TTD), Coupa Software Inc. (COUP), Zscaler, Inc. (ZS) are just three examples that are fast-growing companies and big winners in the market this year and not included in QQQ. A full list of VGT holdings can be found in its semi annual report. 
VGT vs. QQQ stock style exposure. Source: YCharts
VGT is simply a different approach to tech investing, and while a case can be made that the internet companies deserve a spot in the fund, we like the wider diversification and greater exposure to small-cap companies. We note that VGT has a lower expense ratio at 0.10% compared to 0.20% for QQQ, which isn’t major but nevertheless another strong point. VGT also has a higher dividend yield at 1.2% over the trailing twelve months compared to 0.8% in QQQ.
Data by YCharts
Performance
What’s impressive here is that despite not including “FANG” names, VGT has managed to outperform QQQ in recent years. VGT is up 26% year to date in 2019 compared to 20% for QQQ. Over the past five years, VGT has returned 120.6% compared to 94.2% in QQQ. The strong performance of stocks like V and MA among the top VGT holdings has in part driven this excess return. Down the list is its smallest holdings, many of the software-as-a-service type companies have also been big winners in VGT, boosting the returns.
Data by YCharts
Risk Metrics
The other side to this performance based on the higher weighting towards mid- and small-cap companies suggests VGT may be more volatile and have greater downside risks considering the exposure to riskier stocks. The data below shows that all-time QQQ had a max drawdown of 83% which occurred from the peak of the tech bubble in the year 2000. Since VGT’s inception data came after in 2004, it did not include that period but more recently we can look at the extreme levels of volatility observed in Q4 2018.
During Q4 last year, VGT witnessed a drawdown of 24% compared to 23% in QQQ, slightly worse. Even still, the current 30-day rolling volatility at 25.23% is also higher than the 23.36% in QQQ confirming our point that VGT presents slightly higher risk metrics. QQQ has a higher risk-adjusted return as measured by the Sharpe Ratio going back 10 years at 1.284 versus 1.189 in VGT. It’s close but the date nevertheless shows that VGT has a marginally higher risk.
VGT vs. QQQ risk metrics. source: YCharts
Takeaway
We view the Vanguard Information Technology ETF as a good option among tech-focused, exchange-traded funds. VGT has a different approach to passive tech sector exposure than QQQ and it’s difficult to claim one is “better” or worse than another. We like VGT since it’s more diversified and a better representation of the broad themes in the area, although the exclusion of internet information companies is an odd parameter within the tracking index’s methodology. It’s important for investors to understand the composition of the exchange traded fund holdings.
Considering the low expense ratio and higher yield, we make the case that VGT deserves consideration as a core holding position, with the caveat that we’re on the sidelines awaiting a pullback from current levels. We like the fund but have an overall more bearish view on the market with an expectation of downside for the tech stocks in general. The higher weighting towards small-cap growth stocks suggests there could be a greater downside risk relative to QQQ should market and economic conditions deteriorate. Please take a look at the fund’s prospectus for a full list of risks and disclosures.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Investing includes risks, including loss of principal.
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