Recent returns for VOO and VTI seem to confound conventional wisdom that stocks of small and medium companies outperform large-cap issues in the long run.
By Mitchell Martin, Forbes Staff
Two of the five biggest U.S. exchange-traded funds are a pair of siblings from the low-cost Vanguard family that have not been performing as you might expect over the past five years. The Vanguard S&P 500 ETF (known by its VOO ticker) sports $473.4 billion of shares in the large-capitalization shares that comprise the Standard & Poor’s 500 index, and the more complex Vanguard Total Stock Market ETF (VTI) includes more than 3,700 additional issues that provide exposure to small and medium-sized U.S. companies and weighs in at $406.9 billion of assets. Both funds have rock-bottom annual expense ratios of 0.03%.
All of VOO’s assets and about 87% of the holdings of VTI (on a dollar basis) comprise S&P 500 stocks, according to data from the ETF Research Center. That means that VTI has a little less exposure to the S&P 500, especially the most valuable members of that index. Jeff DeMaso, editor of the Independent Vanguard Adviser, calculates that about 31% of VOO’s portfolio is accounted for by stock-market darling Nvidia, along with Microsoft, Apple, Amazon, Alphabet and Tesla. VTI’s exposure is only 27%.
Alongside its slimmer S&P 500 holdings, VTI has positions–each topping out at around 0.3% of its assets–in smaller businesses like homebuilder Toll Brothers, retailer Dick’s Sporting Goods, and Robinhood Markets, the discount brokerage.
VANGUARD’S SIBLING RIVALS
Behemoths VOO and VTI have similar portfolios but VOO has more of the market-driving large-cap tech.
In theory, that diversity should be a good thing. Returns on large-capitalization businesses have trailed those of small companies in the stock market since the 1920s, with the bigger companies gaining about 10% vs. 12% for their smaller counterparts. There are several possible explanations for the small-stock outperformance, but the basic concept is that they are inherently riskier and investors therefore demand higher long-term returns to own them, as authors Roger G. Ibbotson and James P. Harrington wrote in the 2021 edition of Stocks, Bonds, Bills, and Inflation. “It is not clear,” they added, “whether this is due to size itself or to other factors closely related to or correlated with size.”
In the contest between the Vanguard funds, however, the addition of the small stocks in VTI does not seem to have led to better performance over the past decade than the large caps alone—at least on a superficial basis. Fact sheets for the two investments show VOO beating VTI for each of the last 1-year, 3-year, 5-year, and 10-year periods through March 31, although both funds had sizable gains in all those periods. The disparity this calendar year is especially wide, with VOO returning 15.3% on a net-asset-value basis through June 21 vs. 13.5% for VTI. Much of that outperformance occurred in the current quarter.
When you compare fund returns for specific periods, the start and end dates can have an outsized effect on the results. To give a fairer picture, investors can look at rolling returns, which take into account the annual results for each year in a stated period rather than just measuring from the start date to the end. Because VOO only began in 2010, Forbes asked Vanguard to supply 10-year rolling data whose earlier years were based on similar mutual fund portfolios rather than the ETF itself.
BIGGER LOOKS BETTER
Performance history of Vanguard S&P 500 ETF (VOO) and Vanguard Total Stock Market ETF (VTI)
Looking at it that way, over the 10 years through 2023 each fund had the best return five times and all of the wins were consecutive streaks. VTI prevailed from 2014 to 2018 and VOO had the better results in 2019 to 2023. Measured another way, investors who put equal sums of money into both funds once a year for the last 10 calendar years would only have been about 3% ahead in VOO, and it only took the lead in in 2021.
The reason VOO has done better? The top U.S. technology companies are on a tear.
“Large-cap stocks, mainly growth-oriented technology stocks, posted stellar returns and paced the market, helping VOO outperform VTI,” Mo’ath Almahasneh, associate manager research analyst at fund specialist Morningstar, tells Forbes by email. He notes that VTI’s previous outperformance dates back to the early 2000s. Indeed, the Vanguard rolling data show the VTI streak beginning in 2005 and running for 14 consecutive years before VOO took over.
VOO’s recent strength came from tech gains during the Covid-19 pandemic, when lockdowns and work-from-home encouraged greater use of online services. As that benefit waned it was replaced by an enthusiastic welcome for artificial intelligence (AI). “Today, the key theme driving returns is clearly anything expected to benefit from the latest developments in artificial intelligence,” says Morningstar’s Eric Compton, director of equity research for the technology sector.
The poster child is Nvidia, whose chips developed for computer graphics have found new uses in AI, which explains how the company came to be the top holding in VOO and why VTI’s lower exposure hurts the fund.
ROLLING RETURNS CHANGE THE PICTURE
When considered on a 10-year rolling basis, VOO’s outperformance is not as commanding
One effect of that reduced allocation to big-cap tech is that Morningstar gives VTI a three-star rating, compared with the top five-star review of VOO. But that rating is backwards-looking, says Almahasneh, and it was brought about by the restrained performance that reflects the allocation mix. He points to the company’s forward-looking Medalist system, which ranks both ETFs as gold, meaning they are expected to add the most value among similar funds over a period of at least five years.
So the question for investors considering the two ETFs—or any similar choice between a broad-market fund and one more exposed to big tech companies—is how sustainable the large-cap outperformance may be.
“A couple things could slow down the high flying returns for the group,” Morningstar’s Compton tells Forbes by email. “The first item is simply current valuations, which have already priced in solid growth for the main AI beneficiaries. For example, we think a lot of the obvious hardware AI beneficiaries are fully valued and even overvalued in some cases.” That could lead to reduced gains or even declines in the high-flying AI sector. But probably not today or tomorrow, Compton adds.
“Over the short term, we do not expect that to happen, as a lot of the key growth items, such as GPU sales for Nvidia, seem to be derisked for the next several quarters given current order backlogs, but if outlooks start to show unexpected deceleration, watch out,” he says. Nvidia’s graphics processing units, a kind of computer chip, is widely used to power hardware for artificial intelligence and also in mining bitcoin.
On the other hand, technological innovation is one of the reasons that the U.S. economy keeps growing more quickly than those of other developed nations.
“To the extent that future technological innovation continues to favor the leaders and consolidated markets,” says Compton, “expect the larger companies to maintain their dominance.”
That would be a plus for VOO, but it requires a lot of positive elements to maintain the outperformance based on tech components of the S&P 500. Considering the modest difference in returns between the two funds and with VOO trading at 26.1 times earnings at the end of May versus 25.1 for VTI, you would either have to have a lot of faith in the large-cap tech sector’s ability to continue to lead the market or considerable disdain for the idea that smaller stocks will outperform over the long haul.
Vanguard itself does not like to offer market commentary, but spokesperson Michael Nolan provides a macro outlook that would give at least a slight edge to VTI: “Over the next 10 years, Vanguard expects the average annual return on U.S. large-cap stocks to be in the range of 3.1% to 5.1%, and U.S. small-caps to be between 4.3% and 6.3%.”
For DeMaso of Independent Vanguard Advisor, VTI has a slight edge. “If I were picking one today, I’d lean towards Total Stock Market,” he tells Forbes by email, “given that the giant tech companies can’t carry the market forever. Or said differently, eventually, smaller stocks will outperform. Just don’t ask me when!”
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