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ETF Overview
Vanguard Information Technology ETF (VGT) owns a portfolio of large-cap technology stocks in the United States. The fund tracks the information technology sector of the MSCI US Investable Market 25/50 Index. VGT is an ETF that should deliver strong growth over time as tech companies tend to invest their profits towards research and developments in order to drive future growth. However, the company’s portfolio is concentrated as the top 5 stocks consists more than 40% of the total portfolio. Since we are likely already in the latter stage of the economic cycle, we feel investors may want to reduce exposure to IT sector such as VGT and rotate some cash towards other defensive sectors or wait on the sideline.
Data by YCharts
Fund Analysis
A concentrated portfolio
VGT has a concentrated portfolio. As can be seen from the table below, Microsoft (MSFT) and Apple (AAPL) account for about 15% of the portfolio due to its market-cap weighting approach. Its top 5 holdings represent about 42% of its total portfolio. This concentration can introduce significant risk especially if one or a few of these stocks performs poorly.
Source: Morningstar
Large-cap tech companies with competitive positions
As the table below shows, nearly 85% of its portfolio consists of large-cap or giant-cap companies. These are companies that are well established and consistently deliver top and bottom line growth. As a result, these stocks are less volatile than its other small or medium-cap peers in the same sector.
Source: Morningstar
An ETF tilted towards growth than dividend
Due to the nature of technology industry, tech companies tend to reinvest their profits towards research and developments to keep their competitive advantage and to fuel future growth. Therefore, VGT’s dividend yield is not particularly attractive for income investors. As can be seen from the chart below, its trailing 12-month dividend yield of 1.2% is low compared to SPDR S&P 500 ETF’s (SPY) 1.85%.
Data by YCharts
Instead, stocks that VGT holds tend to outperform the broader markets due to their strong growth over time. As can be seen from the chart below, VGT’s fund price increased by nearly 392.6% in the past 10 years while the S&P 500 Index only increased by about 210.4%.
Data by YCharts
Low management expense ratio
Vanguard charges a low management expense ratio of 0.1% for VGT. Its MER is slightly higher than Fidelity MSCI Information Technology ETF’s (FTEC) 0.08% but lower than Technology Select Sector SPDR ETF’s (XLK) 0.14%.
Macroeconomic analysis: When to invest in VGT
Information technology sector can perform poorly in an economic downturn
The IT sector is generally more sensitive to the business cycle than other sectors. In an economic recession, businesses will spend less in technology products or services. Services companies such as Mastercard (MA) and Visa (V) (also part of VGT’s portfolio) will likely see their revenue decline as consumers constrain their spending. This cyclical nature of the sector is important for investors to keep in mind. On the other hand, companies in the IT sector can benefit in the initial stage or mid-stage of the economic cycle as businesses and consumers resumed their spending due to an improved outlook.
As can be seen from the two charts below, IT sector outperformed many other sectors in the early cycle and mid-cycle phases of the economic cycle. In fact, VGT also followed the same pattern and performed very well in the early cycle phase in the past. In 2009, VGT’s fund performance of 61.2% was much better than S&P 500 Index’s 23.5%.
Source: Fidelity: The Business Cycle Approach to Equity Sector Investing
However, investors should also keep in mind that IT sector can underperform in late-cycle and recession phase (see two charts below).
Source: Fidelity: The Business Cycle Approach to Equity Sector Investing
As the chart below shows, VGT’s fund price declined by 43.4% in 2008, the year the stock market crashed. This was worse than S&P 500 Index’s 38.5% decline Therefore, an investment in the late cycle environment can be quite risky.
Data by YCharts
Where are we in the current economic cycle?
The current economic cycle has been well into its 10th year. The economy in the United States continues to run at a full capacity. In Q1 2019, U.S. GDP growth rate reaccelerated to 3.2%. In the same time, its unemployment dropped to 3.6%. This is the lowest we have seen since 1969. However, the Federal Reserve has taken a wait-and-see approach and not in any hurry to raise interest rates as inflation continues to be well below its 2% target. In addition, the uncertainties caused by the trade tensions between the United States and China may have the potential to derail the U.S. economy.
In this late stage of the economic cycle, VGT may not be the best place to park your money given the fact that we know IT sector may underperform in an economic recession. Therefore, investors may want to consider reallocate some funds from VGT towards other defensive ETFs such as Vanguard Communication Services ETF (VOX) or Communication Services Select Sector SPDR ETF (XLC).
Investor Takeaway
VGT is a low-cost ETF choice for investors seeking to invest in large-cap technology stocks. However, since we are already in the latter stage of the current economic cycle, we believe conservative investors may want to reduce its exposure to VGT and rotate the funds toward other defensive ETFs such as communication services ETFs.
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: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.
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