2 “Concentrated” Ways to Own Value Stocks

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We have seen a big shift in investor appetite away from traditional value companies and into highflying growth names over the last several years. That trend has continued in 2015, but recent market volatility may have investors reconsidering the fundamental qualities of the stocks in their portfolio.

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Growth stocks tend to fall harder during corrective phases as investors flock to the safety of defensive or value-oriented sectors. Furthermore, the August correction may afford an opportunity to purchase value funds at attractive prices when compared to broad equity benchmarks.

Two relatively new ETFs came across my watch list as potential candidates for investors seeking an outside-the-box approach to value stocks. Both funds are built using a more concentrated portfolio focused on value stocks with solid balance sheets and sound business fundamentals.

Value ETF: ValueShares U.S. Quantitative Value ETF (QVAL)

ValueShares U.S. Quantitative Value ETF (QVAL) is an actively managed ETF that debuted in late 2014 and has amassed more than $51 million in assets spread among 40 to 50 individual holdings. This fund is managed by Wesley R. Gray who has written extensively on the attributes of quantitative values and behavioral finance. Top current holdings include Best Buy (BBY), Tech Data (TECD), Big Lots (BIG) and NetApp (NTAP).

QVAL uses three separate screening criteria to hone in on a focused number of stocks that it believes offer solid value and quality, long-term business fundamentals. The goal is to invest in the cheapest high-quality stocks to try to outperform a more passive index.

The ValueShares fund benchmarks its performance versus the iShares S&P 500 Value ETF (IVE), and so far this year it has been able to maintain a similar total return. Prior to the recent correction, this actively managed ETF was actually significantly outperforming the passively managed yardstick.

QVAL chart

It’s worth pointing out that IVE is a market-cap-weighted index of 359 holdings, while QVAL takes a more equal-weighted approach to its portfolio construction methodology. In addition, QVAL charges an expense ratio of 0.79%, compared to 0.18% for its passive counterpart.

The significantly higher fees of the actively managed portfolio are to be expected for a unique strategy using proprietary screening and construction methodologies. Nevertheless, QVAL needs to prove that its approach adds value (pardon the pun) to investors who choose to step outside the passive index realm.

In my opinion, this concentrated value fund should warrant consideration by those seeking an alpha-generating strategy for the value sleeve of their equity portfolio.

Value ETFs: Deep Value ETF (DVP)

Deep Value ETF (DVP) is another value-oriented strategy that debuted in 2014. This fund is based on the TWM Deep Value Index, which is constructed of 20 dividend-paying stocks within the S&P 500 index with solid balance sheets, earnings and free cash flow.

According to the Tiedemann Wealth Management website, the companies within the index are weighted based on a “rules-based assessment of their valuations so that stocks that are most attractively valued receive a higher weight.” In addition, the full index is reconstituted annually, and the part of the index with the bottom 10 companies is reconstituted quarterly. Top holdings currently include Computer Sciences (CSC), GameStop (GME), Verizon (VZ) and Frontier (FTR).

The extremely concentrated nature of the DVP portfolio makes for an interesting study in what is essentially a smart-beta index. The smaller number of holdings will likely create a greater divergence from the benchmark than a more traditional approach.

This ETF will be more susceptible to the individual business risks and opportunities of the underlying stocks than its peers as well. I would expect that the DVP portfolio will experience pronounced periods of underperformance and outperformance depending on the prevailing market environment.

DVP has managed to accumulate more than $200 million in total assets and charges a similar expense ratio as QVAL at 0.8%. This ETF is certainly worth a look for investors who like the comfort of a passive index with a stock picker’s mentality.

Bottom Line

There are pros and cons to selecting ETFs that fall outside the traditional realm of low-cost and well-diversified benchmarks. However, both of these value funds offer a unique approach to concentrated value investing that should not be overlooked. They can potentially add value as tactical positions that compliment your core ETF portfolio.

David Fabian is Managing Partner and Chief Operations Officer of FMD Capital Management. To get more investor insights from FMD Capital, visit their blog.

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