Value investing is back. But how do you choose the right ETF?

Over the past decade, growth stocks have outperformed value stocks, which typically have a lot of tangible assets relative to their market value. According to the S&P Dow Jones Index, over those 10 years, the S&P 1500 Composite Growth Index has an annualized total return of 16.4% through March 31, compared with an overall S&P 1500 for the S&P 1500 and 11.9% for the S&P 1500 Composite Value Index. in comparison.

“U.S. markets are naturally inclined toward growth, with a heavy emphasis on technology stocks,” says Matthew Krajna, co-chief investment officer at Nottingham Advisors.

Lately, though, value has been having a moment and has been largely trashing valuable, high-flying growth stocks. The S&P 1500 Price Index is down just 0.2% over the past three months, while the S&P 1500 Growth Index is down 8.6%. Is it sustainable? Over the past two decades, there have been a lot of false starts for value as a hyperaware Federal Reserve kept interest rates historically low – effectively weeding out growth investors by making money cheaper. But that is no longer the case, as the Fed has started raising rates.

Exchange-traded funds offer several ways to take advantage of this newfound power in value stocks. The 101 price ETFs on the market offer different approaches for investors: Some track indexes, while others are driven by quantitative, and sometimes proactive, strategies. Some value ETFs also screen for leverage and earnings, impose sector restrictions and reevaluate their portfolios or as often as daily.

Adding value ETFs to an existing portfolio requires an understanding of how value fits in. Here’s what to keep in mind when choosing a value ETF.

the basics

What is a Value Stock? Simply put, one that has a low price-to-book ratio (P/B) — a measure of market cap relative to tangible assets. The lower the price-to-book ratio, the deeper the value. Value strategies often overlap with dividend-focused income strategies — as many value stocks are more established companies in traditional dividend-paying sectors such as financial services, consumer companies and healthcare.

Value was cemented as a source of return in the early 1990s when two University of Chicago professors, Eugene Fama and Kenneth French (now at Dartmouth College), found that high-book-value companies Consistently outperformed the market. His initial study analyzed returns from 1963 to 1991. Better performance continued in an additional study from 1991 to 2019.

Headline-making growth companies haven’t deterred value-minded ETF investors. According to FactSet, as of March 31, the value-focused ETF had assets of $409 billion, while the growth ETF had $368 billion.

index (and size)

The first consideration for choosing a value ETF is index construction.

For example, to create the S&P 500 Value Index, use the price-to-book, price-to-earnings (P/E) and price-to-sales (P/S) ratios to create the S&P Dow Jones Index value score. evaluates. Companies such as Warren Buffett’s Berkshire Hathaway, Procter & Gamble and Johnson & Johnson rank higher, in contrast to growth-index leaders Apple, Amazon.com and Microsoft, which are built on sales and earnings growth and share-price momentum. go.

The size of the companies that an index covers—large-cap, midcap, etc.—is also important. Research by M/s Fama and French also showed that small-cap stocks outperformed large-caps over the period of the study – but focusing on smaller companies carries risks.

“Value can pay off particularly well in the small-cap space,” says Dana D’Auria, co-chief investment officer at Envestnet. But smaller values ​​will bring more volatility than larger ones, so investors who are pay-hungry Buying at a lower price should consider an all-cap approach that includes stocks with a high-octane small-cap value.”

According to FactSet, there are 30 different US large-cap value ETFs, including 10 midcap options, 16 small-cap options, and 20 for the total market. For example, Vanguard, iShares and State Street Global Advisors all offer an S&P 500 Value ETF based on a large-cap index, which includes approximately 450 securities. (Other ETFs cover stocks of international value.)

Then there is the issue of the number of components in the index. More inclusive value indexes cast a wider net for stocks, so they often include some growth stocks — because those stock values ​​meet certain criteria for equity.

Therefore, value ETFs that narrow down the list of potential stocks tend to have holdings with greater value characteristics. The Invesco S&P 500 Pure Value ETF (RPV) narrows the value index to just 120 companies, pushing the financials to 32% of holdings (compared with 16% for the S&P 500 Value) and a price-value of 1.3 compared to 3.1. Delivers two-book. for S&P 500 value (and 8.7 for S&P 500 growth).

Investors who want to amp up the value factor can look for highly focused ETFs (about 50 holdings) or leveraged juiced returns. For example, the Direxion Russell 1000 Value Over Growth ETF (RWVG) uses an ETF with total return swaps to create a 150% exposure to the Russell 1000 Value Index and a 50% short exposure to the Russell 1000 Growth Index. (There’s also a growth-to-value offering.) Rebalanced monthly, this ETF will exaggerate the spread between the two factors.

But experts warn that the less diversified a value fund is, the more likely it is to fall into a “value trap”.

“One of the big risks inherent in value investing is buying undervalued stocks to see them fall even further before they drop,” says Ms. D’Auria. “One way to guard against this is to incorporate other screen factors, such as quality and speed, into your value sleeve.”

Multifactor (and more)

ETFs also offer a variety of investment strategies for investors. A common approach is called a “multifactor”, which is more dynamic than just following an index. ETFs are often restructured or rebalanced, often leaning on factors such as equity, profitability and limited leverage.

A handful of ETF managers are pursuing the right actively managed ETF strategies, including index-like quantitative strategies that give the manager more discretion. For example, the Avantis US Small Cap Value ETF (AVUV) holds 630 stocks of Russell 2000. The ETF may re-evaluate its portfolio daily. It also eliminates regulated utilities and real-estate investment trusts.

Before you choose an approach, experts recommend careful consideration – especially if you try to time the market with short-term bets.

Mr Krajna of Nottingham Advisors cautioned investors: “How far do you want the value to go? Is this a strategic holding – over three years – or more strategic?”