Vanguard FTSE 250 ETF: May 2024 Update

• Vanguard is a pioneer in index investing and launched its first ETF in 2001

• This ETF provides exposure to a range of UK medium-sized companies

• It’s a low-cost way to track the performance of the FTSE 250 index

How it fits in a portfolio

An ETF is a basket of investments that often includes company shares or bonds. They tend to track the performance of an index such as the FTSE 250 Index and trade on stock exchanges, like shares. This means their price fluctuates throughout the day.

Find out more about ETFs

The Vanguard FTSE 250 ETF invests in 250 medium-sized UK companies. These businesses make more of their money domestically, so they’re less reliant on foreign economies than some of the larger companies in the UK. That said, the FTSE 250 Index also includes investment trusts, some of which invest in overseas markets and provides the ETF with some international diversification.

An ETF is one of the simplest ways to invest and can be a low-cost starting point for an investment portfolio aiming to deliver long-term growth. ETFs that focus on the UK’s medium-sized companies could help diversify a long-term global portfolio, or one focused on larger companies or other investments such as bonds.

Manager

Vanguard is a pioneer when it comes to passive investing, having created the first retail index fund over 45 years ago. It now runs some of the largest index funds in the world. Given its size, it has a big investment team with the expertise and resources to track indices and markets as closely as possible, while having scale to keep costs down.

Vanguard ETFs are run by a large, global team. They’re spread across three investment hubs around the world – the US, UK and Australia. This team-based approach means there’s no named manager on the ETF. As a collective team, Vanguard has run this ETF for nearly 10 years.

Vanguard also has a trading analytics team, which is responsible for ensuring the ETFs buy and sell investments efficiently and at a competitive cost. This involves analysing data from different brokers and banks. Lower costs should help the ETFs track their benchmarks as tightly as possible.

Process

This ETF aims to track the performance of medium-sized companies in the UK, as measured by the FTSE 250 Index. It does this by investing in all 250 companies in the index and in the same proportion. This is known as full replication and should help the ETF track the index closely.

Financial companies make up a large part of the ETF and their weighting in the fund was 45.2% at the end of April 2024. This was followed by industrials, consumer discretionary and real estate which made up 15.7%, 12.5% and 9.7% of the ETF respectively. The companies in this ETF are smaller compared to those in the FTSE 100, which is the UK’s 100 largest companies. Whilst smaller companies have more room to grow than larger ones, they do carry more risk.

Reducing costs is a key part of keeping the tracking difference between the ETF and the benchmark to a minimum. In any ETF, factors like taxes, dealing commissions and spreads, and the cost of running the ETF all drag on performance. To help keep these costs down, the team aims to make large investments in companies instead of lots of small transactions.

Vanguard will also lend some of the investments in the ETF to other providers in exchange for a fee, which can be used to offset some of the costs. They will only lend securities to a limited number of high-quality approved dealers. They indemnify the fund against any loss from this process, meaning there should be no negative impact on investors. However, stock lending is a higher risk approach.

As this ETF is listed offshore investors are not usually entitled to compensation from the UK Financial Services Compensation Scheme.

Culture

Vanguard is currently the second largest asset manager in the world and runs around $8.6trn of assets globally as of March 2024. The group aims to put the client at the forefront of everything it does, which drives its focus on quality, low-cost index products.

Jack Bogle founded Vanguard in 1975 and it’s owned by investors. This allows Vanguard to redirect its profits back to investors in the form of lower fees, instead of paying dividends to external shareholders. Bogle believed in creating products that simply track the performance of a market rather than taking a shot at picking individual companies which may beat them.

The team running this ETF works closely with other equity research and risk departments across the business. They have daily and weekly meetings to discuss ongoing strategy which could add good support and challenge on how to run the ETF effectively.

ESG Integration

Vanguard is predominantly a passive fund house. While it has offered exclusions-based passive funds for many years, it has lagged peers in offering passive funds that explicitly integrate Environmental, Social and Governance (ESG) criteria by tracking indices that tilt towards companies with positive ESG characteristics, and away from those that don’t.

Vanguard’s Investment Stewardship team carries out most of the firm’s voting and engagement activity. Their stewardship activity is grounded in the firm’s four principles of good governance: board composition and effectiveness, oversight of strategy and risk, executive compensation and shareholder rights. The Stewardship team produces frequent insights on their engagement activity at both a corporate and governmental level.

Vanguard courted controversy in 2022 when it left the Net Zero Asset Managers’ Initiative, a group of asset managers that have committed to achieving net zero carbon emissions by 2050. It claimed its decision would improve clarity for investors and allow it to speak independently. We view this as a disappointing backward step, but we’re encouraged that the company will continue to engage with companies on climate-related issues.

The Vanguard FTSE 250 ETF tracks an index that does not specifically integrate ESG considerations into its process. The ETF can therefore invest in shares issued by companies in any sector.

Cost

The ETF currently has an ongoing annual fund charge of 0.10%. The annual charge to hold ETFs in the HL ISA or SIPP is 0.45% (capped at £45 p.a. in the ISA and £200 in the SIPP). There are no charges from HL to hold ETFs within the HL Fund and Share Account or HL Junior ISA. Ensuring an ETF has a low charge is an important part of tracking the underlying index closely.

As ETFs trade like shares, both a buy and sell instruction will be subject to the HL share dealing charges.

Learn more about the difference between ETFs and index tracker funds

Performance

Since launch in September 2014, the ETF has tracked the FTSE 250 Index well returning 65.01%* versus 67.73% for the index. As expected from an ETF, it’s fallen behind the benchmark over the long term because of the costs involved. However, the tools used by the managers have helped to keep performance tight to the index. Remember past performance isn’t a guide to future returns.

The performance of medium-sized companies in the UK (6.33%) has lagged their larger counterparts (7.66%) over the last year. The FTSE 250 Index has less exposure to the oil & gas sector compared to the FTSE 100 Index, an area where companies have performed well over the year. The lack of exposure to this sector has meant the FTSE 250 missed some of the gains made by energy companies.

The valuation of smaller companies is more reliant on future earnings growth and cashflows, so inflation and higher interest rates can be a bigger headwind to these companies compared to larger ones. Interest rates in the UK were increased to their highest level since 2008 in August 2023 and over the last couple of years inflation has risen to rates not seen in four decades. This has resulted in higher borrowing and operating costs which have a bigger impact on smaller companies.

Despite these headwinds, the ETF has risen by 6.06% over the last 12 months. It has tracked the benchmark closely which returned 6.33%. Interest rates have remained stable since August and the next move is expected to be down rather than up. Despite inflation being high, it has been on a downward trend throughout the year and is getting closer to its 2% target. This could benefit smaller companies and has also improved sentiment in the UK.

Given Vanguard’s size, experience and expertise, we expect the ETF to continue to track the benchmark well in the future, though there are no guarantees. A glance at the five-year performance table below shows that the ETF has delivered both positive and negative returns in line with the performance of the index.