IVOV: A Mid-Cap Value ETF By Vanguard

IVOV Strategy and Portfolio

The Vanguard S&P Mid-Cap 400 Value ETF (NYSEARCA:IVOV) has been tracking the S&P MidCap 400 Value Index since 09/07/2010. It has 299 holdings, a 12-month distribution yield of 1.82% and an expense ratio of 0.15%. The same portfolio is also available as a mutual fund (VMFVX). The fund is a direct competitor to iShares S&P Mid-Cap 400 Value ETF (IJJ) and SPDR S&P 400 Mid Cap Value ETF (MDYV), which track the same index and have similar management fees.

The Vanguard fund is smaller and less liquid than its peers.

As described by S&P Dow Jones Indices, S&P 400 constituents are classified in value and growth subsets using three valuation ratios and three growth metrics. The valuation ratios are book value to price, earnings to price and sales to price. By construction, 33% of S&P 400 constituents exclusively belongs to each style, and 34% belongs to both styles. The value subset serves as S&P 400 Value Index and is rebalanced annually. It is capital-weighted, with an adjustment for constituents belonging to both styles. For example, a company with a value rank better than its growth rank is given a larger weight in the Value Index than in the Growth Index. The turnover rate was 33% of the average portfolio value in the most recent fiscal year.

The aggregate valuation ratios of IVOV are lower than for its parent index, represented in the table below by the SPDR S&P Midcap 400 ETF (MDY). However, the difference is not as large as we could expect.

Source: Fidelity

The top 3 sectors are the same in IVOV and MDY, but not in the same order (see next chart). Financials dominate in the value index, whereas industrials come first in the broader index. Also, these top 3 sectors are better balanced in the value index. Compared to MDY, the value fund overweights financials, consumer discretionary and real estate. It almost ignores energy.

The next table lists the top 10 holdings with their weights and main valuation ratios. Their aggregate weight is 8.2% and none of them is above 1%, so risks related to individual companies are very low.

Ratios: Portfolio123

Performance

Since inception (09/07/2010), IVOV is almost on par with MDY in return and risk metrics.

Data calculated with Portfolio123

IJJ tracks the same underlying index, and it is much older (07/24/2000), so it may be used to assess the S&P MidCap 400 Value Index on a longer period. The value index has outperformed the parent index by 1.17 percentage point in annualized return (see next table). Risk measured in drawdown and standard deviation of monthly returns (volatility) is similar.

Data calculated with Portfolio123

The next chart compares IVOV since inception with MDY and 2 other mid-cap value funds based on different indexes: iShares Russell Mid-Cap Value ETF (IWS) and iShares Morningstar Mid-Cap Value ETF (IMCV). The Vanguard fund is the best performer by a short margin.

It is also ranked first in the last 12 months, and it is the only one in the list above break-even (as of writing).

Comparison with my Dashboard List Model

The Dashboard List is a list of 60 to 80 stocks in the S&P 1500 index, 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. An exception in utilities: the Price/Free Cash Flow is not taken into account to avoid some inconsistencies. Then, the 10 eligible companies with the highest Return on Equity in every sector are kept in the list. Some sectors are grouped together: energy with materials, communication 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 the underlying index performance since July 2000 with the Dashboard List model, with a tweak: here, the list is reconstituted once a year to make it comparable with a passive index.

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

The Dashboard List beats IVOV by about 2 percentage points in annualized return. ETF performance is real, whereas the model is simulated.

Two Common Shortcomings in Value Indexes

Most value ETFs have two shortcomings in my opinion, and IVOV is no exception. The first one is to classify all stocks on the same criteria. It means the valuation ratios are considered comparable across sectors. Obviously, they are not: my monthly dashboard here shows how 3 median valuation ratios may differ across sectors now and in historical averages. A consequence is to overweight sectors where valuation ratios are naturally cheaper, especially financials. Some other sectors are disadvantaged: those with large intangible assets like technology. Companies with large intangible assets are those with a business model based on massive R&D, or a strong branding, or large user databases, or operating in a field where competition is limited by an expensive entry ticket. All these elements are not correctly reflected by valuation ratios.

The second weakness comes from the price/book ratio (P/B), which adds some risk in the strategy. Historical data show that a large group of companies with low P/B has a higher probability to hold 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 1/1/2000 and 1/1/2023 with elements in equal weight.

Data calculated with Portfolio123

This explains why I use P/FCF and not P/B in the Dashboard List model.

Takeaway

The Vanguard S&P Mid-Cap 400 Value ETF implements a systematic strategy based on value and growth ratios. It has 4 close competitors: MDYV and IJJ have the same underlying index, whereas IWS and IMCV track other mid-cap value indexes. IJJ, IVOV and MDYV are equivalents for long-term investors, but IJJ and MDYV are better than IVOV for tactical asset allocation and trading, because they have much larger trading volumes. For example, they may be part of a strategy switching between value and growth, and/or between large and mid-cap, depending on market conditions. IVOV underlying index has outperformed its parent index, the S&P Mid-Cap 400, by about 1 percentage point in annualized return since 2000. It is a good all-purpose mid-cap value index, but it suffers from two methodological weaknesses, in my opinion: ranking stocks regardless of their industries and relying too much on the price/book ratio.

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