VGT Vs. VTI: Is Tech Or Broad Market Exposure Best Right Now? (NYSEARCA:VTI) (2024)

Introduction

The Vanguard Information Technology ETF (NYSEARCA:VGT) and The Vanguard Total Stock Market ETF (NYSEARCA:VTI) are two of the most pre-eminent products that have made a mark in the ETF arena over the last two decades, accumulating AUM of over $300bn in aggregate! The former provides focussed access to over 360 stocks belonging to the IT sector, whilst the latter is much broader in scope, covering over 4000 large, mid, small, and micro-cap stocks (both growth and value) that trade on the NYSE and the Nasdaq.

How have VGT and VTI been performing?

Over the years, since VGT’s inception in Jan- 2004 (VTI began trading in May- 2001), there’s only been one clear winner in this race; VGT has delivered aggregate returns of 847%, nearly 2x as much as the corresponding return profile of VTI!

However, over the more recent shorter time frame, a different narrative appears to be playing out. January-2022 has been a tricky month for both products, but it’s fair to say that the Vanguard Information Tech ETF has suffered greater blows. From a return angle, VGT is down in double-digit terms of 10.55%, ~250bps worse off than the Vanguard Total Stock Market ETF.

But that doesn’t tell you the whole story; it’s also worth considering in which direction the general liquidity is moving, and this certainly doesn’t make for pleasant viewing as far as VGT is concerned; in Jan-2022, the ETF has seen net fund outflows to the tune of-$900m, whilst VTI has accumulated positive aggregate net flows to the tune of nearly$4000m. The implication here is that whilst both ETFs are witnessing price depreciation of their holdings, a greater proportion of market participants are currently gravitating towards VTI.

So, what does all this mean for VGT? Should you be shunning this ETF and rotating towards an ETF such as VTI that is more diversified and broader in scope? I don’t believe there’s a definitive answer here, but I'd like to lay out certain considerations that may be helpful in assisting prospective investors make a decision on the two products.

Why VTI?

Better risk-reward and cheaper valuations

If you juxtapose VTI’s returns relative to VGT’s returns over the last 18 years, you’d note that this ratio looks enormously stretched to the downside; in fact for much of the trading history, this ratio has tended to oscillate within the 0.9-1.25x range. Since H2-2020, the ratio appears to be stabilizing around the 0.54-0.6 levels and looks well-poised to make an attempt towards its old trading range. If mean reversion is something that appeals to you, then rotating away from tech to the broader markets is something you should be considering. I can appreciate that there may perhaps be some structural de-rating that is unlikely to reverse (i.e. over the last few years, the value added by the tech sector to the global economy has been more constructive and irreversible than some of the other large industries that comprise the broader markets) but at these levels, the ratio does feel very oversold and could be due for some reversal.

What adds to this mean reversion case is the significant deviance in the forward valuations of the two ETFs. As per YCharts, VTI appears to be the more promising of the two, trading at only 21.2 its weighted average forward earnings; this represents a 28% discount over the corresponding multiple of VGT (29.2x).

A more well-rounded ETF

Structurally, it also appears that VTI is more well-rounded with an edge across different dimensions. With VGT, even though you get broad access to the tech landscape across 360 odd stocks, note that much of its fortunes will be driven by the top 10 tech stocks who jointly account for ~60% of the total portfolio. When risk-aversion is particularly high, I’m not sure it’s the most prudent thing to be reliant on a narrow pool of stocks. With VTI, you don't get the sense that this portfolio is as top-heavy, with the top-10 stocks accounting for less than 25%.

Then, it’s also just cheaper to hold on to VTI over the long run; the expense ratio only works out to 0.03%. With VGT, this is more than 3x pricier, with an expense ratio of 0.10%. The income angle of VTI too is substantially better; you can currently lock in a yield of 1.32%, which is nearly twice as much as VGT’s corresponding figure of 0.7%.

Why VGT?

Risks tied to the tightening narrative may be less acute for VGT

The popular theory against tech stocks and something like a VGT is that they are unlikely to flourish in an era of rising interest rates. Prima facie, I suspect there could be an “element” of truth to this narrative, but I also think it would be unfair to paint all tech stocks with the same brush.

I believe the tech stocks that would remain susceptible to the tightening narrative are those small and micro-cap names that rose to the top amidst the post-pandemic tech blitz where investors were paying scant regard to the underlying fundamentals and only pursuing them on account of the “tech” tag. Granted a lot of these stocks may yet be growing their topline at a ferocious pace, but they’re also burning a great deal of cash and are unable to generate or maintain positive operating profits. I believe that these are the sort of tech stocks that would be viewed with more exacting standards of discernment even as the Fed tightens rates; investors should understandably demand more bang for buck even as the cost of capital increases. If they can’t deliver, these stocks will just face more vicious bouts of selling.

Conversely, if you look at something like a VGT, its portfolio is predominantly oriented towards large-cap names which account for 94% of the total portfolio. I believe these stocks are just more well-positioned to meet investors heightened expectations of not just growth but “profitable growth”; these businesses have well-diversified operations across the broad tech landscape and are able to exbibit their clout when it comes to pricing or passing down costs or extracting favorable deals from their suppliers.

Then the reason why I say that the tightening regime may not necessarily be too much of an issue for VGT is that traditionally it has coped relatively well during conditions such as this, particularly once the initial hike is out of the way. The last time the Fed tightened rates were under Janet Yellen in late 2015 (by 0.25%), after holding it close to zero for seven straight years. As can be seen from the image below, this first hike did result in a 13% drawdown in VGT but once investors were able to digest the initial readjustment, VGT continued to cope just fine over the next four successive hikes; even as the Fed funds rate continued to trend up over the next two years, VGT continued to largely stabilize or post significant gains over time (drawdowns if any, were not of the same magnitude seen post the first hike).

Exceptional track record of managing risk and delivering returns

I'm going to drop that hackneyed axiom here before I touch on my next point. - "Past results are no guarantee of future performance". Having said that, I don't believe you can just cast aside VGT's relative supremacy in juggling its volatility and delivering solid returns. The crucial point to note is that it has fared better than VTI regardless of the time period in question- short or long; this emboldens VGT’s credentials even more.

Given the focus on just one sector, it's no surprise to discover that VGT is the more volatile of the two products. Yet, despite the heightened standard deviation, VGT has been able to deliver larger excess returns (returns relative to the risk-free rate) per unit of total risk as measured by the Sharpe ratio (both on a 5-year basis as well as a 15-year basis). Crucially consider looking at the Sortino ratio which shows you how much excess return the ETFs have been able to generate when you consider only downside deviation. Whether it's over a 5-year period or over a 15-year period, VGT is the only ETF that has been able to generate excess returns that are greater than the per unit of downside risk (a ratio greater than >1).

Attractive earnings potential could be used to justify valuations

In the previous section, I highlighted the disparity in valuations between VGT and VTI (on a forward P/E basis VTI trades at a 28% discount to VGT). But what I also didn’t add then is the superior earnings potential on offer with VGT’s constituents. As per YCharts, VGT’s tech constituents are poised to deliver weighted average earnings growth of 25% next year, whilst VTI’s broader market constituents are only expected to deliver weighted average earnings growth of~6%.

I also want to focus on VGT’s top-10 stocks here as they will have a more pronounced impact on the portfolio’s overall performance with a weight of ~60% (VTI’s top 10 only accounts for 25%). After Jan's correction, I believe a lot of these top-10 stocks are trading at more attractive valuations and it is not too often I can say that. A few months back, the average current premium of the forward P/E of the top-10 names, relative to the long-term average, was well in the mid-teens, but currently, you're looking at a rather minuscule premium of just 5% on average.

Besides that, if you consider the “earnings growth” potential of these names and then consider the respective P/Es, I’d say the valuations aren’t too prohibitive. 6 out of the top 10 names are trading at PEG ratios lower than the historical average and the average forward multiple is also lower than the historical average.

Closing thoughts – Is VGT or VTI The Better Pick?

As you can see from what I've written so far, both ETFs offer ample promise in different ways. At this juncture, the structurally superior VTI may appear to offer better risk-reward at cheaper valuations, so I suppose an investor with a relatively lower risk appetite may be better served by pursuing this product.

Having said that, VGT covers a more focused portfolio of large-cap tech names that have the requisite earnings and earnings growth potential to justify high valuations. These stocks when combined, have also traditionally mitigated risk rather well and delivered ample returns, be it over a 5-year period or a 15-year period. I also think that risks tied to the rate tightening cycle may be overstated when you consider VGT’s portfolio. Growth-oriented investors who have been looking for a portfolio of quality tech names at a decent price point have a good opportunity to now get on board with VGT.