Tech ETFs Lose Momentum: Vanguard's Information Technology ETF in Focus

Vanguard's Information Technology ETF (ticker: VGT) has posted a 14.2% return year-to-date through October 25, trailing the NASDAQ-100’s 19.6% and the S&P 500’s 12.1%. For a sector known for growth, these figures raise concerns.

The ETF tracks the MSCI US Investable Market Information Technology 25/50 Index, focusing on major players like Apple, Microsoft, and NVIDIA. These three companies constitute over 50% of VGT's holdings, with Apple and Microsoft alone making up 43%. Such concentration skews performance. NVIDIA has surged 197% YTD due to AI optimism, while Apple’s stock has remained flat. Microsoft’s 34% gain is largely tied to cloud computing revenue growth.

Market volatility adds to these concerns. The Federal Reserve's hawkish stance in September pressured tech valuations. Rising bond yields, particularly the 10-year US Treasury yield reaching 4.93%, have impacted high-growth sectors reliant on future earnings. "Tech stocks have benefited from an environment of near-zero interest rates for the past decade," said Yuko Saito, equity strategist at Nomura Securities. "That era is clearly over, and investors are adjusting their expectations."

Investor flows into VGT reflect this hesitancy. The ETF recorded net inflows of $2.1 billion year-to-date, according to Vanguard’s October 2023 fund report. However, September marked the first monthly net redemptions since April 2022, with $310 million in outflows. "Investors are diversifying into safer or income-generating assets," noted Saito.

Despite these challenges, VGT’s expense ratio of 0.10% remains competitive, undercutting BlackRock’s iShares U.S. Technology ETF (IYW) at 0.39%. However, low fees may not offset underperformance. Joseph Tan, portfolio manager at Daiwa Asset Management, cautioned against over-reliance on past performance. "Low fees are important, but they mean little if concentration risk erodes returns during market corrections," he said.

Sector breakdowns reveal further investor reconsideration. More than 70% of VGT’s portfolio is in software and semiconductors, with smaller allocations in IT services and hardware. Semiconductor momentum, previously driven by AI and cloud expansion, appears to be slowing. The Philadelphia Semiconductor Index fell 4.5% in October, reflecting profit-taking and inventory concerns.

The tech outlook remains mixed. Although AI dominates discussions, execution often lags. Alphabet’s recent earnings report showed decelerating cloud revenue growth, leading to a 9.5% drop in its stock. This had immediate repercussions for ETFs like VGT, given Google’s 3.4% weight in the portfolio.

Investor sentiment may be shifting. Tech-focused ETFs saw $18.7 billion in global inflows during the 2020 pandemic rally, but this trend is reversing. Morningstar data indicates inflows into US tech ETFs are down 34% compared to 2022. "What we’re observing is less a rejection of tech and more a recalibration," said Tan. "The days of hyper-growth assumptions are being replaced by realistic assessments of cash flow and scalability."

For current VGT investors, the choice is whether to hold or pivot. Historically, the ETF has provided consistent returns, with a 15.1% annualized 5-year return as of September 30. However, its high beta of 1.18 against the S&P 500 indicates vulnerability during downturns.

Alternatives to VGT are gaining traction. Broad-market ETFs like Vanguard Total Stock Market ETF (VTI) offer tech exposure without concentration risk, while dividend-focused funds like Schwab U.S. Dividend Equity ETF (SCHD) attract those prioritizing income. "Investors are questioning whether sector-specific ETFs still make sense in a maturing market," said Saito.

As 2024 approaches, macroeconomic factors could shape tech’s future. Persistent inflation and continued Fed tightening may compress high-multiple stocks further. Conversely, a soft landing or rate cuts could renew interest in growth investments. Vanguard remains optimistic about tech's long-term prospects, describing digital transformation as "a lasting growth driver" in its Q3 fund commentary. The sustainability of this optimism hinges on earnings resilience in the coming quarters.

Vanguard’s Information Technology ETF is at a crossroads. Its low-cost structure and historical performance provide a solid base, but the sector’s susceptibility to macro shifts and concentration risks has dampened enthusiasm. Investors must confront key questions: Is tech growth worth the volatility? If not, where can capital find safer refuge?