Tag Archives: value-portfolio

Looking For Value From Vanguard

My article last week looked at the long-term benefits to holding a diversified portfolio that included a tilt to large cap and small cap value stocks globally. To illustrate the results, I used the structured asset class mutual funds from Dimensional Fund Advisors (DFA) as my proxies for the value stock categories, unlike the market indexes, where I substituted Vanguard index funds. Why not use Vanguard results across the board? Vanguard has an obvious expense ratio advantage over DFA and just about everyone else, and investors have voted with their wallets – Vanguard has more assets than any other mutual fund company. The issue is, when you look to Vanguard for value, they either don’t measure up or don’t even offer strategies for a given asset class. Take a look at the table below. FUND/Index 3/1993-12/2015 6/1998-12/2015 1/1995-12/2015 DFA US Large Cap Value fund (MUTF: DFLVX ) +9.8% Vanguard S&P 500 fund (MUTF: VFINX ) +9.0% Vanguard Value Index (MUTF: VIVAX ) +8.8% DFA US Small Value fund (MUTF: DFSVX ) +9.1% DFA US Small Cap fund (MUTF: DFSTX ) +8.5% Vanguard Small Value Index (MUTF: VISVX ) +8.1% DFA Int’l Value fund (MUTF: DFIVX ) +6.0% MSCI EAFE Index +4.7% MSCI EAFE Value Index +5.3% DFA Int’l Small Value fund (MUTF: DISVX ) +7.4% MSCI EAFE Small Cap Value Index +7.0% Vanguard manages index funds in the US covering large and small value stocks. But they don’t capture as much of the value “premium” as the asset class funds from DFA do. Since 1993 (DFLVX inception), the DFA US Large Value fund outpaced the Vanguard Value Index (net of a higher expense ratio) by 1% per year. Since 1998 (VISVX inception), the DFA US Small Value fund outpaced the Vanguard Small Value Index (net of a higher expense ratio), again by 1% per year. Surprisingly, the Vanguard value funds even underperformed the S&P 500 and small cap “market” funds, despite the fact that these “neutral” (holding both growth and value) funds obviously have less exposure to value stocks than the Vanguard value indexes. This should dispel any myth that the Vanguard underperformance is due solely to “less exposure to the value factor.” Things get considerably more challenging with Vanguard once we leave the US market. Vanguard doesn’t offer an index fund that buys international large value stocks or small value stocks. You’re stuck with a plain-vanilla market index like the MSCI EAFE. The chart above finds, since 1995 (DISVX inception), the DFA Int’l Value fund bested the EAFE Index (before expenses associated with an actual index fund that buys EAFE stocks) by 1.3% per year. The DFA Int’l Small Value fund did 2.7% per year better. Clearly, there’s a significant cost (return drag) to investing only in international market indexes that doesn’t show up in simplistic expense ratio comparisons. But what if Vanguard did offer large and small value indexes in foreign markets? Would they be worth a look? Here I’ve reproduced the returns on a likely index provider – the MSCI EAFE Value and EAFE Small Value Indexes – for comparison purposes ( source: DFA ReturnsWeb ). These indexes don’t have any fees, and any index fund or ETF that tracks them would likely trail the index return by 0.2% to 0.3% or so. Even still, the apples (net of fee DFA fund return) to oranges (gross of fee index returns) comparison shows a clear advantage to DFA : The DFA Int’l Value fund did +0.7% per year better than the EAFE Value Index while the DFA Int’l Small Value fund did +0.4% per year better than the EAFE Small Value Index. The lack of value stock indexes from Vanguard in non-US markets isn’t just a return issue, either. Large and small foreign value stocks also have lower correlations to US asset classes and have provided an additional diversification benefit. What accounts for these significant net-of-fee differences that are consistent across geographical regions over meaningfully long periods of time? First, as previously mentioned, DFA does hold a deeper subset of the lowest-priced value stocks, about the cheapest 30% compared to the cheapest 50% for Vanguard. And the small cap funds hold almost purely small and micro cap stocks compared to small and mid cap stocks for Vanguard. DFA screens out stocks with low-to-negative profitability and when buying and selling, they do so patiently throughout the year, hanging on to companies with positive momentum while waiting to buy stocks with the strongest negative momentum. And, finally, DFA is a more active security lender, earning a few more basis points on average from lending out stocks overnight and earning a return (that gets credited back to the fund) for doing so. All of this adds up to much purer asset class exposure with noticeably better long-term returns that is not isolated to just one area of the market. I like Vanguard . T hey’ve done a good job of educating investors on the importance of broad diversification and minimizing fees. But given the option, in the crucial asset classes that belong in a “core” diversified portfolio*, I just don’t see the value in using Vanguard. *I would add that the DFA US Large Cap Equity fund (MUTF: DUSQX ) and DFA Five-Year Global fund (MUTF: DFGBX ), which cover the other two core asset classes not discussed in this article, represent superior options to the Vanguard S&P 500 fund and the Vanguard Short-term Bond Index fund as well, but the reasons are beyond the scope of this article. Past performance is not a guarantee of future results. Mutual fund performance shown includes reinvestment of dividends and other earnings but does not reflect the deduction of investment advisory fees or other expenses except where noted. This content is provided for informational purposes and is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services. Disclosure: I am/we are long DUSQX, DFLVX, DFSVX, DFIVX, DISVX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

A New ETF In Town: The PowerShares S&P 500 Value Portfolio

Summary The value portfolio offers an academically proven investment model for investors. P/E, P/B and P/S are well known and commonly used financial metrics. Even though this ETF seems a bit boring, based on an abundance of academically proven factors I would prefer this ETF over an index ETF following the S&P 500. Invesco recently launched new ETFs, one of them I covered in an earlier article: ” A New ETF In Town: The PowerShares S&P 500 Momentum Portfolio (NYSEARCA: SPMO )”. This is part 2, discussing the PowerShares S&P 500 Value Portfolio (NYSEARCA: SPVU ), which is an interesting addition to the S&P 500 momentum portfolio. Both momentum and value are 2 investment strategies which have received wide coverage in the academic world and the world of finance practitioners. The SPVU tracks the S&P 500 enhanced value index which is focusing on 100 S&P 500 companies with the greatest value score calculated based on fundamental ratios: book value/price ratio, earnings/price ratio and sales/price ratio. SPVU: The Value Portfolio Source: ETFdb The issuer of this new ETF is Invesco, a large independent investment management company incorporated in Bermuda which has many other ETFs to offer. The expense ratio of 0.25% is a very reasonable number . With 2.5 million assets under management it’s not a large ETF. Value Portfolio: Selection Strategy This ETF is a so called smart-beta ETF and will spend at least 90% of its total assets in the S&P 500 Enhanced Value Index. The selection process for 100 stocks is based on the book value/price ratio, earnings/price ratio and sales/price ratio: The book value to price ratio is calculated by using the company’s latest book value per share divided by its price. The earnings to price ratio is calculated by using the company’s 12-month earnings per share divided by its price. The sales/price ratio is calculated by using the company’s 12-month trailing 12-month sales per share divided by its price. A value score is then calculated. The best 100 stocks are selected for the underlying index. Value: A much covered topic in the world of academia The book value to price ratio is an asset factor which has been widely covered in academics. For example, a P/B of 2 means that the stock is priced twice as much as it could sell for. It is also used to explain the portfolio return of portfolio managers, in for example academic models such as the Fama and French asset model . Generally, a firm with a lower book value to price ratio outperforms a firm with a higher book value to price ratio. A reason for this could be that a firm with a lower ratio indicates a distressed stock which makes it look cheap. Yet, if you believe in the efficient market hypothesis , a cheap stock could only be a cheap stock because investors consider it risky. The price to earnings ratio (the inverse of the earnings to price ratio) is one of the most widely used fundamental ratios in the financial markets. For example a P/E of 20 can indicate that you pay $20 for $1 of earnings. If then compared to numerous other investments, commonly it seems like a better deal if you pay the least for $1 of earnings. It has been proven, time and time again, that investment in a lower P/E related firm outperforms investments which yield a higher P/E ratio . Nevertheless, the world of academia has further expanded on price/earnings ratios recently, for example, in the discrepancy between negative P/E firms and positive P/E firms. Athanassakos (2014) concluded in his research that certain negative P/E firms indicate high forward stock returns, even though past price/earnings ratio research most of the time excluded negative P/E firms. I believe future research in the world of financial academia will continue in this path. The price to sales ratio is the third metric which is used in this ETF to value stocks. A lower P/S is preferable over a higher P/S ratio. Furthermore, it’s one of the best metrics used for companies which are a in a so called ‘turnaround’ modus, where the firm has lost earnings (negative P/E and no dividend for example), the P/S ratio offers the opportunity to compare firms. Additionally, the P/S also has been covered numerous of times in the world of academia where the outcome and conclusion is often very similar to each other. The price to sales ratio offers a good (to sometimes even better) explanatory power in explaining stock returns in comparison to for example the book-market value of a stock. All in all, this ETF follows 3 well known financial metrics which have been proven in the world of academics, decade after decade. Conclusion In addition to the momentum strategy ETF I consider it highly likely that this ETF will outperform the stock market as a whole over an extended period of time. This assumption is based on the abundance of research on the book/price, price/earnings and sales/price ratio in the world of academics. Yet, as the world of academia is moving forward, I would not be surprised to see updated Value ETFs where new metrics/findings will be implemented. I assume based on the current findings in academia that they will offer better risk/reward premiums to investors in comparison to this ETF. The world of negative P/E firms has yet to be uncovered to the same extent as positive P/E firms. Disclaimer: This article provides opinions and information, but does not contain recommendations or personal investment advice to any specific person for any particular purpose. Do your own research or obtain suitable personal advice. You are responsible for your own investment decisions. This information is not a recommendation or solicitation to buy or sell securities, nor am I a registered investment advisor.