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VAS vs VHY: Unpicking Vanguard’s two largest Australian ETFs

ETF Watch - Jun 12, 2018

Vanguard’s Australian Shares Fund (VAS) is no doubt a favourite of many Australian ETF investors. With over $2.6b in funds under management and almost $1b new investments in the last 12 months, it is now the second largest ETF in Australia.

Vanguard’s other large Australian based share fund, Vanguard Australian Shares High Yield Fund (VHY) has recently passed the $1b mark, adding almost $300m over the last year. Australian ETF investors have a penchant for yield, and a common question asked by investors seeking yield is should they invest in Vanguard’s broad Australian Share fund or Vanguard’s High Yield option. We take a look at the two funds, how they have performed and how they differ in their makeup.

What are the differences in these funds?

In essence VAS is a broad based Australian share fund, investing in the 300 largest companies available on the ASX. We had a good look at VAS some time ago when we compared it to its similar peers.

By contrast VHY invests in the same universe of companies, however includes screening criteria to invest only in companies with higher forecasted dividend yields than the overall market. It invests in a much smaller amount of companies, currently just 42. 39% of VHY’s portfolio makeup is identical to VAS. VHY is a High Yield Smart Beta ETF. You can have a look at all of the yield focused ETFs available on the ASX in a previous post.

How has the performance differed?

The below chart outlines the performance of VAS and VHY since VHY’s inception in May 2011. It includes reinvestment of all dividends. It can be seen that VHY got off to a flying start, and by 2015 had performance history materially higher than VAS. This was during an era where high yield was really in favour. Global interest rates were are record lows and investors were prepared to pay a premium for high yielding companies. Additionally, companies such as BHP, not usually known for high yield, became high yielding companies in the depths of the resources rout. It was also a prosperous time for the high yielding banks as they improved their performance off the back of the GFC.

This changed in 2015, when it became clear that record low global interest rates would not last forever, bank profits were coming under threat on the back of new regulatory requirements, and some of the traditionally high yield paying companies like Telstra began facing headwinds. By the end of May 2018, performance of the two funds in the 7 year history of VHY has been almost identical.

What about the dividends?

Of course, investors looking for yield are interested not only in the total performance, but also the dividend yield. Below we outline the dividend yield of each over the period from 2012 to 2017. In all periods VHY’s dividend yield exceeded VAS, however not by as much as may be expected. In some periods it may be by as much as 2.5% and in other periods as little as 0.19%. In the high yield periods, a large proportion of the distribution is realised capital gains, indicating VHY’s approach leads to higher portfolio turnover.

How do the portfolios differ?

What may be surprising to some is VAS and VHY’s portfolios are quite different. 39% of VHY’s holdings are the same as VAS, and the top 10 holdings for each are materially different. Below we show the top 10 holdings of VAS and how these allocations differ to VHY:

Ticker VAS VHY VHY difference
CBA 7.65% 7.92% 0.27%
BHP 6.02% 0.00% -6.02%
WBC 5.91% 8.44% 2.54%
NAB 4.77% 6.83% 2.06%
ANZ 4.75% 6.84% 2.09%
CSL 4.67% 0.00% -4.67%
WES 3.01% 10.08% 7.07%
TLS 2.29% 9.38% 7.09%
WOW 2.21% 0.00% -2.21%
MQG 2.08% 2.91% 0.82%

VHY is providing a more concentrated portfolio, with only 42 holdings and the top 10 accounting for 68% of the total. The big banks are well represented, but low dividend payers, BHP and CSL are not. VHY also includes high weightings to traditionally high yielding infrastructure investments, APA and Aurizon.

VHY’s approach to portfolio selection

VHY follows the FTSE ASFA Australia High Dividend Yield Index. The index consists of ‘companies with higher forecast dividends relative to other companies listed on the Australian Stock Exchange’. No more than 40% of the index can be invested in any one industry, and no more than 10% in one company.

In 2016, the AFR reported one of the pitfalls of this approach. In 2015 after BHP and Rio Tinto had suffered huge falls in their share price during the resources rout, they refused to change their progressive dividend policies. The share price falls had meant these were two of the highest yielding companies on the ASX, and as a result met VHY’s  screening criteria, and were included in the portfolios.

Most analysts at the time believed BHP and RIO’s dividend policies were unsustainable, and not surprisingly, a short time later in 2016, they slashed their dividends. Meanwhile VHY had accumulated almost 20% of its portfolio in their two companies, before selling them at the next portfolio rebalance (the fund rebalances twice a year). This coincides with VHY’s period of underperformance.

This just highlights a risk that exists with ‘Smart Beta’ type ETFs like VHY, where the fund invests according only to the rules of the index. At times they are forced make investing decisions that skilled humans would not make.

Conclusion

VAS and VHY are both low cost Australian share ETFs, with VAS available for 0.14% pa and VHY 0.25% per annum. The most recent investment cycle has shown periods of outperformance of both options, with 7 year performance roughly the same. For those looking for yield, VHY generally does provide higher distributions than VAS, however part of these distributions tend to be realised capital gains due to the portfolio's higher turnover.

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