Even if you get the top spot, there’s no guarantee that you will stay there. In September, I declared VUG as my preferred asset for Large-Cap Growth, but suggestions from two readers bring two new challengers: will QQQM or IWY prove a better fit in a Risk Parity portfolio?
Good to start with a look back at my original write up of large-cap growth ETFS.:
In short, I tested VOO, VUG, IVW and DFUS, and found that VUG and IVW were better fits for a Risk parity portfolio when paired with small-cap value (preferred asset: AVUV, by the way). VOO and DFUS weren’t disappointing funds at all, I just found that if you already have AVUV or something similar, then VUG and IVW give your portfolio more stretch between the two sides of equity investing.
That post prompted two readers to suggest other funds I could have considered. Pete suggested I take a look at QQQ or QQQM, and Jeffrey proposed IWY as a challenger to VUG. Here at Risk Parity Chronicles, we’re always happy to respond to reader requests, so here’s the challenge match!
Recall that the question for the last test was “What large-cap growth fund should I use when I also have a significant allocation to small-cap value?” This assumes a two-part equity strategy, and a focus on US equities only. Since that test, I have also declared DFAX as my preferred asset for non-US stocks, so if you wanted, you could see the large-cap growth portion as one of the three legs in the stool alongside AVUV and DFAX. To be clear, this is not the fund to choose if I could only have one equity fund, or wanted to keep my holdings as simple as possible.
Vanguard Growth ETF. Fund page, Barchart Summary. Essentially, a more growth-tilted version of the S&P 500, which is already tilted towards large-cap growth, of course. Tracks the CRSP US Large-cap Growth Index. Technically, this is not exclusively a large-cap fund, but only 12.4% of holdings are mid-cap or lower, so it’s large-cap enough for me. In the original post, I also found that IVW (iShares S&P 500 Pure Growth ETF. Fund page, Barchart Summary) was a great fund to consider, as well. To simplify matters, I won’t test it here, though.
Invesco Nasdaq 100 ETF Fund page, Barchart Summary. Reader Pete suggested I look at QQQ or QQQM for their high recent returns and seemingly large correlation gap with AVUV. The funds are identical in terms of composition and index that they track (the Nasdaq 100). Of the two, Pete noted that QQQM has a slightly lower expense ratio, to which I can add another benefit of being able to reinvest dividends due to its structure as an ETF (Not a trust, as QQQ is). I do prefer QQQM over QQQ but it is much newer (October 2020 compared to March 1999), so I’ll be putting QQQ through the tests, but ultimately make a recommendation about QQQM.
iShares Russell Top 200 Growth ETF. Fund page, Barchart Summary. Reader Jeff brought this one to my attention, commenting that it was even larger and more “growth-y” than VUG, and also backtested well in a pairing with small-cap value. Certainly seems that at first glance - focusing on the growthiest companies in the Russell 200, and with less than half of the holdings of VUG (for the record, QQQ has even fewer).
The Basics (full comparison from Portfolio Visualizer here)
All have low expense ratios, and though it may be tempting to gravitate towards VUG, .15% or .2% are still low enough that we shouldn't make decisions based on a few basis points. IWY is a pretty small fund, so be aware that it will likely have higher bid/ask spreads. Given it is an iShares fund in a popular niche, I wouldn't worry too much about liquidation.
How Will I Decide?
I’ll use mostly the same evaluative criteria as I did in September. What exactly am I looking for with this large-cap growth fund?
- I want as much diversification from small-cap value. I’ll test these against VBR, VIOV and AVUV.
- I’m paying attention to their composition. I want it to contain the largest, biggest US companies, and be the other end of the barbell from small–cap value. I’ll look for it to have higher valuation ratios, suggesting market expectations for growth.
- Above all, performance is key. I suspect this asset will be volatile, and I suspect it will underperform funds like small-cap value over the long-term. In the shorter-term, though, I want to find a fund that when it is booming, is really booming. I am looking for high returns over long time frames, with high capture of market upside.
First Criterion: Diversification Compared to Other Equity Funds
The idea behind combining small-cap value and large-cap growth is that your portfolio can benefit by investing in both contestants in a neck-and-neck race. In this case, growth tends to beat value (in the short-term) before losing out to value in the long run, so you’d invest in both, buying more of the one that is relatively cheaper at any one time. sIn the accumulation stage, you wind up getting more of the laggard at a great price, and then In the decumulation stage, you can gain more by selling the one that has done better.
As usual, I used Portfolio Visualizer’s Asset Correlation tool to compare these three large-cap growth funds with three small-cap value funds: VBR, VIOV, and AVUV. Due to the relative youth of AVUV, I actually wound up running three correlations (one for each small-cap value fund), so the numbers below show the correlation of each asset as far as it goes back in each case:
Looks like QQQ has the biggest departure from the pattern of returns of the small-cap value funds, with IWY just a smidge behind. VUG is the most correlated with each of the small-cap value funds, though in the grand scheme of things, there really isn’t that much difference between any funds in terms of correlation.
Second Criterion: Seeking the Largest, Growth-iest Fund
I took a closer look at the composition of each fund to get a sense of how concentrated each was. For most equity funds, I’m actually looking for a wide variety of holdings, but for this one particular element of a hypothetical RP portfolio, I’m actually looking for fewer, and for the ones remaining to consist of larger companies by market cap and with higher valuations. Percentage in Large-cap and weighted market cap gives us a sense of how large-cap each fund is, and weighted price-to-equity and price-to-book ratios gives us a sense of how the market views the constituent companies in the funds. The data is from the ETF.com profiles for each fund:
From this simple comparison, it looks like IWY best fits the bill for size. For growth, VUG is highest for market valuations in terms of P/E, while IWY is highest for P/B.
I wanted to go one step farther with my analysis to see what the actual holdings of each fund could tell us about the strategy. Data for QQQ and IWY was easy to handle, and I’ve copied and pasted the full holdings for both of those funds. The data for VUG was harder to manage, though, since there were no portfolio weights given, plus the holdings were published in groups of 10. For VUG, I copied and pasted the top 50. Assuming that the percentages are in the neighborhood of the other two, then holdings lower than #51 would be at most .5%.
From the chart, you can see a great deal of overlap, with Apple, Microsoft, Amazon and Alphabet the top 4 of each fund. As you scan lower, you see continued similarity between VUG and IWY, with QQQ departing from the other two a bit. The reason is that QQQ’s mandate is to follow the 100 largest companies by market cap offered on the Nasdaq exchange. Its mandate is NOT to track growth companies, though for pretty much the entirety of its existence, Nasdaq has been synonymous with that mission.
But, it doesn’t have to be, and I am wondering whether QQQ is really the strategy I’m looking for, or just has accidentally resembled it. If we took the Top 100 companies listed on the Tokyo Stock Exchange in 1989, it definitely would have been a “growth” index. By 2009, not so much. Meanwhile, VUG and IWY are free to invest in large-cap growth stock funds regardless of exchange. If the best happen to be on Nasdaq, then so be it, and BUG and IWY would reflect that. But if not, then you’re dealing with a screen for where the stock is listed, which isn’t what I want it to do.
It’s also a screen that will lead to some included assets I don’t want for this strategy. To offer a quick example, Meta is the ninth largest unique holding on QQQ, with 2.1% of the total, but as of day I’m writing this, it has a P/E at 10.7, and a P/B at 2.4. Those are both multiples we’d expect out of value stocks!
Third (and most important) Criterion: Performance
This asset class breaks some of the rules I follow with others. Usually I’m all about looking beyond simple returns numbers and instead look at a fund’s volatility profile and Sharpe ratio. Yet for large-cap growth, here I am eschewing those in favor of raw returns, plain and simple. I have three different timeframes for tracking CAGR, one year, five years, and since September, 2009 (IWYs debut).
I also included two other stats to consider: 1) the annualized alpha should give us a sense of what else these funds are doing beyond just adding market risk, and 2) upside capture ratio, which measures how much the fund has outperformed the benchmarks in up markets. In the portfolio, I’m looking for this asset class to take advantage of good times and drag the portfolio forward, and this is my indicator. Both of these stats are since the fund’s inception. Here is the link, by the way.
All three are in the same ballpark, though QQQ and IWY have slightly better seats than VUG. QQQ has had the best performance, with the highest annualized alpha, the most upside capture and the best CAGR when times have been good.
So, After All that, Are Either of the Two Challengers Better than VUG?
Going into these tests, I don’t root for one fund or another, though I do root for clarity. In previous tests, it’s been clear that one fund in a group is superior, but for this test, the clearest thing we can say is that the picture is muddy.
For the first test, regarding correlation, all three funds were close to each other, with QQQ eking out the smallest of positive margins over IWY.
For the second test, regarding composition, all three were again close, but this time IWY was just a bit larger and a bit more growth-y than the other two.
Then, for the last test of performance, QQQ has the edge again over two other fairly similar funds, all things considered. Still, the higher upside capture and alpha numbers are important indicators.
Still, QQQ doesn’t quite fit what I’m looking for. Yes, it’s performance has been the best, and if this blog came with a free time machine, it’d be my choice for a large-cap growth fund from 1999 to the present. But, it doesn’t have to be this way, and I wonder if the link between the tech sector and growth stocks will endure, especially as more and more tech companies take on the characteristics of Meta. Is what is going on with Meta a sign of things to come, or just an outlier? I don’t know, but it does tell me that if I want large-cap growth, I should confine myself to the ones that happen to be listed on Nasdaq. I don’t mean to imply that QQQ is not a worthy investment. It may be, and has the past performance to make you feel optimistic. But I would consider it more as a sector bet, and not as a key part of a Risk Parity portfolio.
That leaves VUG and IWY, and of the two, I’d actually recommend IWY, meaning a challenger has won and it is now the preferred asset for large-cap growth. It was the look at its holdings that did it. IWY is a more concentrated bet in the asset class, and as such, makes it a better complement to AVUV or your chosen small-cap value fund.
What good is the knowledge of better funds if you don't act on it? VUG currently appears in the RPC Stability portfolio, but I'll be replacing it with IWY with the November 2022 Portfolio Review coming soon.