A one-stop U.S. equity holding

Gold-rated Vanguard U.S. Total Market Index covers the entire U.S. stock market for a paltry 0.16% expense ratio.

Jeffrey Bunce, CFA 7 February, 2017 | 6:00PM

 Vanguard U.S. Total Market Index ETF (VUN) is the quintessential core U.S. stock holding, providing investors with an excellent choice for passive exposure to a broad portfolio of U.S. stocks at a low cost. As such, VUN warrants a Morningstar Analyst Rating of Gold.

VUN proves that sometimes "more is more." Unlike an S&P 500 fund or the typical U.S. equity mutual fund, this ETF has a stake in small- and micro-cap stocks. This may result in some added volatility when smaller stocks lag, but investors have been rewarded for accepting this additional risk over the long term. For instance, during the 10 years ended December 2016, VTI has returned 8.7% (in Canadian dollars), beating the S&P 500 by 0.3 percentage points a year. This performance is also good enough to outpace approximately 90% of the fee-based U.S. equity mutual funds in Canada. VTI accomplished this favourable return with only a slightly higher standard deviation (15.8%) than the S&P 500 (15.3%). While smaller stocks will not always outperform, the fund's broad diversification should serve investors well regardless.

This ETF invests in U.S.-domiciled  Vanguard Total Stock Market (VTI), an ETF that tracks the CRSP U.S. Total Market Index, which holds almost every liquid U.S. stock. It includes all stocks with a primary listing on a major U.S. stock exchange, incorporated or with a major business presence in the United States, with a market cap of at least $10 million, with at least 10% of shares publicly available, and that meet minimum trading requirements. This results in an average market cap for stocks in the index that is about half the typical fund in the U.S. equity category.

While the index includes real estate investment trusts, it excludes business-development companies, American depositary receipts, royalty trusts, and limited partnerships. In general, it should correlate almost perfectly with other broad stock indexes. The fund employs full replication for the largest 1,200 or so stocks and then samples from the remaining smaller-cap stocks. However, this ETF benefits from the large asset base of its U.S. counterpart, which allows for replication of the index better than most other total market funds. The resulting portfolio consists of approximately 3,600 holdings, about the same as the index.

The index's edge extends over active U.S. equity funds. It beats approximately 90% of funds in the U.S. equity category over the past 15 years. Many attribute active managers' collective struggles to best index funds to the overall level of efficiency of the market for U.S. stocks. Efficiency, in this case, is meant to indicate the speed and precision with which market participants incorporate new information into stock prices. But market efficiency alone does not explain the long-term success of broadly diversified market-capitalization-weighted index funds.

Market-capitalization-weighted indexes have some noteworthy drawbacks. By owning the market, investors are relying on other market participants to price stocks on their behalf. While over long stretches of time the market has done a good job valuing stocks, these long horizons have been interrupted occasionally by periods of mania and panic. The most often cited example was the technology bubble, when technology stocks traded at sky-high valuations and subsequently collapsed in price. Periods like this are unavoidable for index investors and create opportunities that have historically been exploited by (some) active managers.

Fees

This ETF has a management expense ratio of 0.16%. This is only 0.08 percentage points higher than the cost of  Vanguard S&P 500 Index ETF (VFV) while providing exposure to a much larger basket of securities. Indeed, in Canada, this is among the lowest-cost and broadest U.S. equity funds that individual investors can buy, although iShares Core S&P U.S. Total Market Index (XUU) is cheaper at 0.10%. VUN's U.S. counterpart, VTI, can be had for an even lower price of 0.05%. Investors with U.S.-dollar accounts that don't need to incur foreign-exchange charges may be better served in the U.S. fund.

Alternatives

In Canada, XUU also provides broad market exposure to the U.S. market. This ETF, replicating the S&P Total Market Index, is newer having just launched in February 2015. Similar to Vanguard, it invests primarily in U.S.-domiciled ETFs to gain broad market exposure. In particular, the fund holds iShares Core S&P 500, iShares Core S&P Total U.S. Stock Market, iShares Core S&P Mid-Cap, and iShares Core S&P Small-Cap ETFs.

For those investors concerned with exposure to the U.S. dollar, currency-hedged versions are available for both Vanguard’s and iShares ETFs. The currency-hedged version of Vanguard U.S. Total Market Index ETF can be found under the ticker VUS. There is no difference in the management expense ratio between the hedged and unhedged versions.

Canadian investors with a U.S.-dollar account or those looking for the pure-version ETF can invest in Vanguard Total Stock Market ETF, which is available on U.S. exchanges. This ETF charges a 0.05% expense ratio and is among the lowest-cost funds that an individual investor can buy. Other alternatives available in the U.S. include  Schwab U.S. Broad Market ETF (SCHB), which has a lower stated expense ratio at only 0.03% but is less liquid and targets close to 2,000 stocks. As a result, it excludes most micro-caps. The  iShares Core S&P Total U.S. Stock Market ETF (ITOT) charges 0.03% and holds over 3,700 companies, making for a comparable alternative.

About Author

Jeffrey Bunce, CFA

Jeffrey Bunce, CFA  Jeffrey Bunce, CFA, is a senior investment analyst for Morningstar’s Investment Management group.