Vanguard Mega Cap Value ETF Review (NYSEARCA:MGV)

This article series aims at evaluating ETFs regarding the past performance of their strategies and the quality of their current portfolios.

MGV strategy and portfolio

The Vanguard Mega Cap Value ETF (NYSEARCA:MGV) has been tracking the CRSP US Mega Cap Value Index since December 2007. It has a portfolio of 146 stocks, a dividend yield of 2.7% and an expense ratio of 0.07% (cheaper than SPY).

As described on CRSP website, the underlying index selects “value securities using the following factors: book to price, forward earnings to price, historic earnings to price, dividend-to-price ratio and sales-to-price ratio.”

The fund has a low turnover: 10.8% for the most recent fiscal year. It invests almost exclusively in U.S. based companies (99.4% of asset value).

The two heaviest sectors are healthcare (23.3%) and financials (19.4%). They are followed by industrials (14.1%) and consumer staples (12%). Other sectors are below 9% individually and about 31% in aggregate. Compared to SPY, MGV overweights the top 4 sectors listed above, and also energy and utilities. It underweights all other sectors. Technology is the sector with the largest difference in asset value between the two funds.

As expected, MGV is cheaper than SPY regarding valuation ratios reported in the next table. However, the difference is moderate.

	MGV	SPY
Price/Earnings TTM	15.92	17.97
Price/Book	2.6	3.38
Price/Sales	1.85	2.18
Price/Cash Flow	11.64	13.65

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The top 10 holdings, listed below with some ratios, represent 25.6% of asset value. The maximum weight is below 4%, so risks related to individual companies are moderate.

Ticker	Name	Weight%	EPS growth %TTM	P/E TTM	P/E fwd	Yield%
UNH	UnitedHealth Group, Inc.	3.64%	26.45	26.10	22.85	1.32
JNJ	Johnson & Johnson	3.18%	3.44	23.65	16.13	2.78
BRK.B	Berkshire Hathaway, Inc.	3.03%	-88.96	53.32	19.41	0
XOM	Exxon Mobil Corp.	3.01%	393.29	10.70	7.57	3.59
JPM	JPMorgan Chase & Co.	2.50%	-16.90	8.18	9.14	3.92
PG	Procter & Gamble Co.	2.48%	5.61	21.41	21.18	2.94
CVX	Chevron Corp.	2.09%	703.62	10.50	8.49	3.61
LLY	Eli Lilly & Co.	1.93%	-5.81	52.24	40.97	1.20
PFE	Pfizer Inc.	1.90%	118.65	8.21	6.48	3.82
KO	The Coca-Cola Co.	1.80%	17.92	24.76	22.15	3.23

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Quality

In previous articles, I have shown how three factors may help cut the risk in a portfolio: Return on Assets, Piotroski F-score, and Altman Z-score. In my ETF reviews, risky holdings are companies with at least 2 red flags among: bad Piotroski score, negative ROA, unsustainable payout ratio, bad or dubious Altman Z-score, excluding financials and real estate where these metrics are less reliable.

According to my calculations, 7 holdings are risky regarding these criteria. They represent less than 3% of asset value, which is a good point. My usual aggregate quality metrics are very close to the benchmark (see next table).

	MGV	SPY
Altman Z-score	2.6	3.3
Piotroski F-score	6.2	5.9
ROA% TTM	7.5	7.49

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Performance

Since January 2010, MGV has lagged the S&P 500 by about one percentage point in annualized return. It beats its competitor the Schwab U.S. Large-Cap Value ETF (SCHV) by a short margin of 75 bps annualized.

	Total Return	Annual Return	Drawdown	Sharpe ratio	Volatility
MGV	258.31%	10.50%	-33.09%	0.76	14.11%
SCHV	228.46%	9.75%	-34.90%	0.7	14.29%
SPY	306.03%	11.59%	-32.05%	0.81	14.75%

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In 2022, MGV has outperformed both SCHV and the broad index:

Comparing MGV with my Dashboard List model

The Dashboard List is a list of 80 stocks in the S&P 1500 index (occasionally less), updated every month based on a simple quantitative methodology. All stocks in the Dashboard List are cheaper than their respective industry median in Price/Earnings, Price/Sales and Price/Free Cash Flow. After this filter, the 10 companies with the highest Return on Equity in every sector are kept in the list. Some sectors are grouped together: Energy with Materials, Telecom with Technology. Real Estate is excluded because these valuation metrics don’t work well in this sector. I have been updating the Dashboard List every month on Seeking Alpha since December 2015, first in free-access articles, then in Quantitative Risk & Value.

The next table compares MGV performance since inception with the Dashboard List model, with a tweak: here the Dashboard List is rebalanced quarterly to make it comparable with a passive index.

	Total Return	Annual Return	Drawdown	Sharpe ratio	Volatility
MGV	258.31%	10.50%	-33.09%	0.76	14.11%
Dashboard List (quarterly)	353.44%	12.56%	-41.68%	0.73	17.77%

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Past performance is not a guarantee of future returns. Data Source: Portfolio123

The Dashboard List clearly beats MGV and SPY. However, ETF returns are real and the model performance is hypothetical.

Underlying index issues

In my opinion, ranking stocks in the whole universe regardless of sectors and industries is a methodological issue. Valuation ratios are not comparable across all sectors: you can read my monthly dashboard here about this topic. MGV overweights financials because valuation metrics are naturally cheaper in this sector. They are also much less reliable. The methodology also disadvantages sectors with large intangible assets that are not correctly reflected by valuation ratios: cutting-edge R&D, strong branding, large user databases for example. They are especially important in technology, consumer discretionary and communication, which are underweight in MGV.

Another concern about the strategy (and most value indexes) comes from using the price/book ratio (P/B) as a main factor (or its inverse). Speaking probabilities, a large group of companies with low P/B contains a higher percentage of value traps than a same-size group with low price/earnings, price/sales or price/free cash flow. Statistically, such a group will also have a higher volatility and deeper drawdowns in price. The next table shows the return and risk metrics of the cheapest quarter of the S&P 500 (i.e.125 stocks) measured in price/book, price/earnings, price/sales and price/free cash flow. The sets are reconstituted annually between 1/1/1999 and 1/1/2022 with elements in equal weight.

	Annual Return	Drawdown	Sharpe ratio	Volatility
Cheapest quarter in P/B	9.95%	-72.36%	0.48	21.05%
Cheapest quarter in P/E	11.25%	-65.09%	0.57	18.91%
Cheapest quarter in P/S	12.62%	-65.66%	0.6	20.46%
Cheapest quarter in P/FCF	12.23%	-63.55%	0.61	19.05%

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Data calculated with Portfolio123

This explains my choice of using P/FCF and not P/B in the Dashboard List model.

Takeaway

MGV is a large-cap value ETF selecting stocks with a ranking system based on five metrics. It is very cheap in management fees. Aggregate valuation ratios are a bit better than in the S&P 500 and quality metrics are similar. It has lagged SPY since 2010, but beats its close competitor SCHV. It has been more resilient than both of them in 2022 to date. Price history since inception mostly covers a bull market fueled by growth stocks. MGV may outperform in a market cycle more favorable to value investing. However, I see two issues in its methodology: stocks are ranked regardless of their sectors, and the price-to-book ratio is a factor adding risk. I think an efficient value model should compare stocks in comparable sets (sector or industry), like I do in the Dashboard List. This model also prefers price/free cash flow to price/book.