September 23, 2019: Value ETFs

Sep 24, 2019 | Asset-Allocation, Bonds, Economy, Feature, Gold, Headline, Income, Investments, IRA, Markets, Mutual-Funds, Newsletter, Retirement

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Value ETFs

We continue our mini-series on factor ETFs. In this newsletter, we discuss value ETFs.

Value investing, or investing in stocks with cheap valuation, has been one of the oldest methods. Value has been well recognized as a main factor that can affect and outperform a broad base market index. Intuitively, it makes sense as buying cheap stocks and waiting for them to appreciate should do better than buying stocks without consideration of their expensiveness.  

Various value metrics

There are various metrics to gauge how expensive a stock is. This leads to various ETFs. The following table shows some of the main large cap value ETFs: 

Large cap ETFs Performance Comparison (as of 9/20/2019):
Name Expense 1Yr AR 3Yr AR 5Yr AR 10Yr AR 15Yr AR
VLUE (iShares MSCI USA Value Factor) 0.15% -4.1% 11.4% 7.4%    
VTV (Vanguard Value ETF) 0.04% 2.3% 12.6% 9.2% 12.1% 8.4%
IWD (iShares Russell 1000 Value) 0.19% 2.6% 10.0% 7.2% 11.1% 7.7%
SCHV (Schwab US Large-Cap Value ETF) 0.04% 2.7% 11.4% 8.3%    
IVE (iShares S&P 500 Value) 0.18% 3.8% 11.1% 7.9% 11.3% 7.5%
VOOV (Vanguard S&P 500 Value ETF) 0.15% 3.9% 11.0% 7.9%    
VTI (Vanguard Total Stock Market ETF) 0.03% 3.0% 13.6% 10.1% 13.1% 9.2%

Several observations:

  • Vanguard ETFs have one of the lowest expense ratios. Schwab’s ETFs are now pretty much matched with Vanguard’s in terms of expense ratios. Note, in an index world, 0.1% expense can make a big difference for the returns. 
  • Five different value indexes are involved here: Vanguard’s VTV: CSRP value index. VLUE: MSCI Value Factor. IWD: Russell 1000 (large cap) value index. SCHV: Schwab’s own value index. IVE and VOOV: S&P 500 Value index. 
  • Vanguard’s VTV has outperformed all other ETFs. It’s 5 year record has been better than others by 1-2%, a very meaningful outperformance. 
  • All value ETFs have underperformed broad base index ETF like VTI for the past 5, 10 and 15 years. Of course, we all know that value indexes have underperformed for quite a while now. We will have some more discussion on this later. 

MSCI value factor ETF VLUE has underperformed. Taking the expense ratio difference, it’s probably comparable with Russell’s value index. So not two indexes are equal here. In fact, considering the noticeable outperformance of VTV, one should choose a value index carefully. 

Based on MSCI’s literature, MSCI US value index is composed of book value weight, sales value weight, earnings value weight and cash earnings value weight. The index actually outperformed its own MSCI USA (broad base) index: 

However, once its expense (0.15%) is taken into account, we suspect it won’t outperform its broad base index. 

The literature also shows it slightly outperformed since 1974 (without expense consideration): 

The outperformance for the past 45 years is so slim. It shows that value investing has suffered greatly for the past long period.

Future of value investing

The trouble of value indexes’ underperformance is somewhat concerning. There are several reasons that might explain this: 

First, for the past 10 years since the last bear market in 2008-2009, growth has greatly outperformed. So the last 10 years’ history has greatly skewed the long term performance. 

Second, it’s also acknowledged by value investors like Warren Buffett that it has become much harder to find good value stocks in recent years, unlike early years in 60s or 70s. Reasons cited include information has become widely available and has become instant; there are more capable investors who are now scouring value stocks harder. 

Third, we have long maintained that value investing just takes advantage of one market inefficiency: buying cheap. It does not solve selling high issue. Often high quality value stocks tend to keep outperforming until they become overly expensive. Simply rebalancing by buying cheapest while being forced to sell stocks that just show their promise does not straightforwardly translate into outperformance. Perhaps, a more sensible value tilted index would be buying quality value stocks and sell only when these stocks become overly expensive?

Of course, as history often shows, it’s very likely that the tide will eventually turn and value probably will outperform in years to come. Unfortunately, no one knows for sure when. 

To summarize, though value investing is not perfect and underperformed recently, as always, investors should be patient. On the other hand, value investing should be complemented by other factors to mitigate its weakness that can last for a long period of time. In a future newsletter, we will show that combining value and momentum can just accomplish this. 

Market overview

The momentum to value rotation and interest rate correction (from low to high) seem to end last week. High growth stocks’ prices have somewhat recovered and are now stable. Depending how one view it subjectively, current stock markets can be characterized as tired (over stretched) or resilient (hanging just hair lower from their record highs). However, as we have pointed out, other than large cap stocks, small cap and mid cap stocks are still way lower than their last August/September highs: 

Unless these small or mid size stocks have risen above their previous highs, it’s hard to call the current market healthy. At any rate, we call for caution because of the high valuation and way extended market levels. Again, the best action is to stay the course and manage risk accordingly. 

For more detailed asset trend scores, please refer to 360° Market Overview. 

In terms of investments, even after the recent retreat, U.S. stock valuation is still at a historically high level and a bigger correction is still waiting to happen. It is thus not a good time to take excessive risk. However, we remain optimistic about U.S. economy in the long term and believe much better investment opportunities will arise in the future. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot. 

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