Vanguard CRSP total index versus a value and growth combination of the same index?

Question

I am currently researching Vanguard Mid-Cap and Vanguard Small-Cap indexes. The methodology for inclusion in these indexes is outlined in the CRSP Methodology Guide.

According to the guide, inclusion in the general index requires several factors. For example, it has to be listed on specific exchanges and have qualifying volume indicators among other things. I don't see, however, any fundamental indicators for inclusion in the index such as price to earnings or price to book.

CRSP has a subset of indexes that qualify stocks using additional metrics such as price to earnings and future growth. To me, this seems like a better investment because it is limiting inclusion in the index to a subset of important fundamental factors. So, as a result, this makes me want to own 50% value and 50% growth, versus being 100% the entire index. The major downside to this, however, is that you are facing a higher expense ratio and a much higher turnover ratio within the fund, which can eat away at returns.

So, my question is, is there a difference between being 100% the index versus 50% the value and 50% the growth index?

Answer 1

The answer to your question depends on the specifics of how the value and growth funds are defined. It would certainly be possible to have two funds that, together, cover the full index with no overlap, but it is by no means certain. However, the difference between holding the two subsets and holding the whole index should be small if the subsets are at all reasonable, which they are likely to be at Vanguard. Therefore I say it is unlikely that there is a practical difference.

There are a couple of things you should be aware of, though. For one, the CRSP indices are theoretical. The document you link to shows what is in the index, not what is in the linked funds. Index funds routinely hold only a subset of the index they are tracking in order to reduce transactions costs--a significant issue in small and mid cap funds. Their objective is to mimic the returns of the index, not match its composition completely. If you want to know the methodology of what is excluded due to price or fundamentals, you should be looking at a Vanguard document, not a CRSP document.

Secondly, it seems like you are laboring under the idea that passive funds should pick stocks based on criteria like "future growth." This is not part of what passive funds do, for the most part. And that's a good thing. Neither you nor vanguard's passive team is capable of designing criteria for picking stocks that will be "better" than investment in the whole index.

In short, buy the whole index. Fees and costs associated with turnover are real and consistent. The differences between the whole index and sub-indices you are discussing are probably not.