While markets are still digesting higher inflation data which has made it clear that interest rate hikes can be implemented much more aggressively in order to tame what has become totally intolerable, I think it’s worth discussing value funds again, as the growth style bears the brunt of this bear party, while cheaper stocks move higher.
The following chart with the year-to-date price returns of Berkshire Hathaway (BRK.B), a pure value stock, and the S&P 500 ETF (IVV) as well as its pure growth portion (RPG) illustrates well this trend.
Today we are going to take a closer look Vanguard US Value Factor ETF (VFVA), an actively managed family investment vehicle launched simultaneously (February 2018) with the Vanguard US Quality Factor ETF (VFQY), which I wrote about a few weeks ago.
As I observe, the fund is not getting the attention it deserves, with only 592 followers on Seeking Alpha, although it certainly has advantages, ranging from robust momentum and minimal expenses to broad equity exposure with attractive quantitative valuation and profitability ratings which, combined, make it an ETF worth considering.
VFVA is not a completely transparent strategy relying on a rules-based quantitative model, this is something you would expect from a non-indexed fund. We know that it is compared to the Russell 3000, a broad market index with no profitability criteria, and that its main objective is to generate long-term capital appreciation by selecting cheaper stocks.
In the prospectus, it only says that the Book/Price and Earnings/Price ratios are used, but the fact sheet contains more clues:
The value factor is measured by book value/price, future earnings/price, operating cash flow/price (for non-financials only).
Although I have to repeat once again that P/B is probably a sub-optimal choice as a somewhat dated multiple, I like that the fund doesn’t ignore the power of cash flow, applying the respective metric where it makes sense.
It is also said that VFVA’s approach is not constrained by the size factor, so it can invest in both indicator and small cap stocks if they are apparently undervalued, depending on market considerations. liquidity; the latter segment offers countless opportunities for bargain hunters due to the size discount, and the Quant data detailed below in the article will once again illustrate this.
Was the strategy focused on long-term capital appreciation by choosing undervalued stocks capable of outperforming the benchmark since inception? Sadly not, but there are a few positives hinting that the styling could well go ahead.
The first group we should look at includes the fund that tracks its benchmark (I chose the iShares Russell 3000 ETF (IWV)), US blue chips (IVV), Fidelity Value Factor (FVAL) and the Invesco S&P 500 Pure Value ETF (RPV), with a limited period from March 2018 to January 2022 (due to VFVA’s relatively short trading history).
Although VFVA is not the worst of the bunch (RPV actually is), its compound annual growth rate is much lower than IWV, while risk measures (standard deviation, Sortino, Sharpe ratios) are mediocre. Among other things, FVAL’s seemingly better performance is more likely a by-product of its growth factor exposure, and not a unique value strategy, as I explained in the recent article.
Please note that the “best year” for IWV, IVV and FVAL was 2019, while for RPV and VFVA it was 2021 when the strong performance (30%+) of the cheaper stocks was reinforced by capital turnover . So, in the event of a tightening in the value style, these names may continue to rise.
I also benchmarked it against other peers, namely the Distillate Fundamental Stability & Value ETF (DSTL), Invesco S&P 500 Enhanced Value ETF (SPVU) and iShares Edge MSCI USA Value Factor ETF (VLUE), over a longer period of time. short, only from November 2018 (this time, because of DSTL).
In this group, VFVA is again not the top performer, but with much better yields compared to SPVU and VLUE.
The fact that DSTL is the best of the cohort indicates that although most of the period analyzed was rather difficult for the style, some passively managed peer funds that do something different (i.e. give the cash flow priority) managed to generate decent returns even in this period. difficult environment, with lower risks (see Sharpe, Sortino ratios) in addition.
Assets. Deepen the valuation
The first thing that can be spotted immediately by looking at the VFVA portfolio is that the ETF avoids maximum heaviness, dispersing risk more or less adequately, with only ~8% invested in ten key stocks in a basket of 816 holdings. Investors who expect a stock mix similar to other “value factor” ETFs (FVAL is worth mentioning here) will be pleasantly surprised, as there are no members of the 1 000 billion dollars inside, even with reduced weightings. As of February 11, AT&T (T), a company of around $175 billion, was the fund’s largest investment, with a weighting of around 0.96%.
The chart below illustrates that as a typical value ETF, VFVA favors financials over information technology, while also being overweight in consumer discretionary, industrials, energy and materials.
Analyzing Quant data, I discovered that over 58% of holdings have valuation ratings of at least B-. That’s a decent result since most value-focused funds I’ve reviewed struggle to achieve that figure, even slightly above 30%. Such a large allocation is certainly a consequence of VFVA’s considerable footprint on small stocks: more than 35% of holdings have a market capitalization of less than $10 billion and a GV of at least B-.
To bring in more color, I created a scatter chart using the valuation data downloaded from the stock screener. Some improvements were needed; First, all companies with missing data points (e.g. negative or unavailable Forward P/E) were obviously factored. Second, a few outliers with 20x+ or even triple-digit P/Bs were also ruled out. For example, Sealed Air (SEE), a mid-cap company with a gargantuan debt to equity of 2,954% and a P/B of 75.3x was removed. Ultimately, the chart below covers around 87.4% of the fund’s holdings.
As can be seen, the densest area is sub-20x Forward P/E and sub-2x P/B, although its footprint in the 2x-4x P/B sector is also significant, indicating that the fund can tolerate seemingly inflated multiples. if it deems it acceptable, or any other measure (eg, cash flow) indicates an understatement.
And here’s what the same chart looks like for IWV (again, with outliers removed like Shoals Technologies (SHLS), Atlassian (TEAM), etc.; I mainly excluded those with P/B greater than 40x the graph covers about 86.7% of the holdings).
From this chart, one can easily notice that this Russell 3000 ETF has a significant footprint in stocks with forward P/Es well above 20x, mostly in the 20x-40x range and of course above, unlike the VFVA.
Additionally, I should point out that VFVA’s growth characteristics aren’t as terrible as one might guess: despite its value bias, about 34% of holdings have growth ratings of B- or better. Quality is also good, lower than most large-cap funds, but still 72% have a profitability rating of B- or better.
The verdict? First, I like its phenomenally low level for an actively managed fund expense ratio of 14 basis points. At the same time, VFVA doesn’t offer anything unique in terms of strategy (P/E, P/B in short), at least as I can tell from its succinct explanation of the value factor in the factsheet , although its exact value formula, especially in terms of stock weighting, is unknown.
The performance is unfortunately not convincing, as some peers have done better. Either way, given that over 58% of its current holdings have attractive valuation ratings, with exposure to the quality factor also important, I’m bullish on VFVA.