The Vanguard Growth Index Fund (NASDAQMUTFUND:VIGRX) is a fund worthy of study. This growth-fund's performance is solely the result of an index portfolio made up of stocks that are selected by rigid criteria, not an all-star active manager.
Despite the fund's mechanical approach to stock selection, it's managed to beat the market over three-, five-, 10-, and even 15-year periods.
How it picks great stocks
Vanguard's fund tracks an index designed by the Center for Research in Security Prices, known as the CRSP US Large Cap Growth Index. This index sorts stocks based on six fundamental factors that it believes will find the best growth stocks in the market. The six factors are as follows:
- Future long-term growth in earnings per share
- Future short-term growth in earnings per share
- Three-year historical growth in earnings per share
- Three-year historical growth in sales per share
- Investment-to-assets ratio
- Return on assets
After scoring each stock, the fund then invests only in the fastest-growing half of U.S. large-cap stocks. The result is a portfolio of stocks that are generally more expensive, but faster growing, than the broad market as measured by the S&P 500 Index.
One of the most notable differences is that the fund is currently overweight in technology -- 25% vs. about 17% -- and consumer cyclical stocks -- 19% vs. 11% -- compared to the S&P 500. It's also relatively underweight in financial services -- 6% vs. 15% -- and utility stocks -- less than 0.1% vs. 3.3% -- neither of which are particularly known for fast growth.
You'll recognize some of growth investors' favorite stocks among its top-10 holdings, which are listed below.
- Home Depot
- Philip Morris International
- Walt Disney
Keeping it simple
Of course, a fund's methodology for stock picking is only half the battle. It's notable that the fund carries an annual expense ratio of just 0.22%, not much higher than more popular stock-index funds, and certainly much-less expensive than the average active fund. The exchange-traded fund variant of this strategy -- Vanguard Growth ETF (NYSEMKT:VUG) -- has an annual expense ratio of just 0.08%!
In addition, the fund tends to hold stocks for a very long time, minimizing turnover, taxes, and transaction costs. Data service Morningstar reports the fund turnover at just 9% compared to 3% for Vanguard's S&P 500 index fund. An average actively managed fund might have a turnover in excess of 100%, thus buying and selling stocks 11 times more frequently than the Vanguard Growth Index Fund.
Its historic outperformance can be simply summed up as a function of picking good growth stocks, and avoiding the common pitfall of high fees and turnover.