Value stocks appear to be staging a comeback after lagging growth names for more than a decade.
Marko Kolanovic, strategist at JPMorgan Chase & Co. in New York, is among the market watchers who say that a rotation into value stocks, which trade cheaply relative to profits or book value, has been under way since September and will continue through the first quarter of 2020. He describes it as a “once in a decade trade.”
For the three months ended Nov. 30, U.S. value-index exchange-traded funds (ETFs) have outpaced growth or momentum ETFs, which own companies that have above-average earnings and/or sales prospects.
Although the jury is still out as to whether this trend will continue, at the very least, value ETFs can be a way to diversify growth-heavy portfolios. Conversely, investors can to turn value ETFs to make a tactical bet as value stocks have outpaced growth over multiple decades.
We asked three ETF experts for their top value picks.
Alex Bryan, director of passive strategies for North America at Morningstar Inc.
Management expense ratio (MER): 0.50 per cent
This ETF offers exposure to mid- to large-cap Canadian value stocks, but its strategy avoids tilting the portfolio toward overpriced names, Mr. Bryan says. The ETF weights companies using fundamental measures of size: book value, sales, dividends and cash flow. “This allows the fund to double down on stocks as they become cheaper and trims positions in stocks as they become more expensive.” The risk is that “it could double down on a stock with deteriorating fundamentals,” he says. In addition, the ETF also has a fairly high weighting of 45 per cent in financial stocks. Top holdings include the five largest Canadian banks. The ETF’s fee is “not a bargain,” he says, but is still fair because it replicates what active managers do, but in a more cost-efficient manner.
The pick: Vanguard Value ETF (VTV-A)
MER: 0.04 per cent
This U.S. equity ETF is compelling because it’s well-diversified with more than 330 names and is one of the cheapest value funds out there, Mr. Bryan says. This ETF, which is listed in the U.S., tracks the CRSP U.S. Large Cap Value Index. Although the fund’s stock weightings are based on market value, “it gives larger weightings to bigger companies, which tend to be better-established firms and a little less risky than some smaller names,” he says. Top holdings include Berkshire Hathaway Inc. (BRK.B-N) and Johnson & Johnson (JNJ-N). The big risk is that “there are going to be periods when value underperforms growth as the past decade has shown.” The ETF also overweights sectors such as financials, which represent about 23 per cent of the fund, and that may not pay off.
Daniel Straus, vice-president, ETF and financial products research, National Bank Financial Inc.
MER: Estimated at 0.34 per cent
This U.S. mid- to large-cap equity ETF is a very pure and cheap value play among Canadian-listed funds, Mr. Straus says. The strategy focuses on weighting stocks based on value factors – that is, low valuations based on fundamentals. Launched in May, it invests in the older U.S.-listed iShares Edge MSCI USA Value Factor ETF (VLUE-A). Holdings include Intel Corp. (INTC-Q), AT&T Inc. (T-N) and Citigroup Inc. (C-N). The fund also keeps its industry sectors similar with its parent benchmark – the MSCI USA Index – but invests in companies with the lowest valuations. The ETF’s focused exposure to value stocks will appeal to investors seeking to bet on a rotation away from growth equities, he adds. “The risk is that, while value looks attractive right now, it’s notoriously difficult to predict these market dynamics.”
MER: 0.49 per cent
This U.S. equity fund, which aims to invest in the cheapest high-quality stocks, is a “very deep-value ETF,” Mr. Straus says. “If value is about to stage a comeback, this is precisely the kind of ETF you want. … But it is not for everybody and requires a lot of discipline.” This U.S.-listed ETF screens for stocks with low enterprise values relative to operating earnings because this metric is seen as less susceptible to accounting manipulation. As the fund owns 40 stocks, there is concentration risk. Top holdings include Tapestry Inc. (TPR-N), formerly Coach Inc., as well as Hollyfrontier Corp. (HFC-N) and Foot Locker Inc. (FL-N). The fund excludes financial stocks so that it’s effectively an “ex-financials value play,” he says. The ETF’s fee is far from cheap, but is still reasonable.
Corey Hurwitz, senior product analyst at Industrial Alliance Securities Inc.
The pick: iShares Canadian Value Index ETF (XCV-T)
MER: 0.55 per cent
This fund, which holds mid- to large-cap Canadian value stocks, is an attractive choice for investors focused on the domestic market, Mr. Hurwitz says. Launched in 2006, the ETF aims to replicate the Dow Jones Canada Select Value Index. It has returned 11.1 per cent for the year ended Nov. 30 and an annualized 7.1 per cent during the past 10 years. The five largest Canadian banks, Suncor Energy Inc. (SU-T) and Barrick Gold Corp. (ABX-T) are among the top holdings. The risk stems from having a concentrated portfolio of 47 stocks with 62 per cent in financials, he says. BMO MSCI Canadian Value Index ETF (ZVC-T), launched in 2017, is another passively managed index ETF, but Mr. Hurwitz says he and his team “favour the iShares fund because of its longer track record.” Its fee is in the median for Canadian equity ETFs.
MER: 0.67 per cent
This ETF offers exposure to U.S. value stocks, but avoids the risk from market-weighted strategies, Mr. Hurwitz says. Indexes based on market capitalization “can result in overweighting stocks that are overvalued and underweighting stocks that are undervalued.” This ETF tracks the Morningstar U.S. Target Value Index, which screens for companies using criteria such as low price to earnings, cash flow, book value and sales. The 50 stocks held in the fund are weighted equally and rebalanced quarterly, but the concentrated portfolio is a risk, he says. Holdings include Bed Bath & Beyond Inc. (BBBY-Q) and Office Depot Inc. (ODP-Q). The ETF’s fee is justified because it’s the only Canadian-listed value ETF focused on the U.S. small- to mid-cap space; this unhedged version also offers diversified foreign-currency exposure.