Value ETFs at Low Ebb

Friday, August 28, 2009

During the Credit Crisis value took it on the chin to the surprise of many who view value as a safe haven. Now value can't buy a break in the 2009 Bull Run either. This is more traditional behavior for value although of little consolation to investors.

We still feel financials are driving much of the value vs. growth race. But value's poor fortunes does not cause us to give up hope. Just the opposite. Value's dramatic and sustained under-performance during the latest three-year cycle suggests that value's time is surely coming:

Above we compare iShares Russell 3000 Value ETF (NYSEArca:IWW) against its growth counterpart. IWW is probably the closest thing to a total market US value ETF.

Value enthusiasts have walked a rough road indeed at times. Although research by Fama and French about twenty years ago spurred many economists to say that value performs better than growth AND atlower risk, value seems to unravel just when the data looks most convincing. Value was popular among academics leading up the the late 1990s bull run and again during much of this decade, but it soon faltered.

Some researchers claim that theoretical out-perfomance by value indexes does not translate into actual investor out-performance, because value stocks are closely held and funds must pay more to load up on them. We are likewise skeptical of the idea that value offers a free lunch of superior performance at lower risk. We advocate a less mathematical and instead a more common sense approach which nonetheless has plenty of basis in historical data. Investors should recognize that long periods of dominance of one over the other are the norm for value/growth, and the longer one has been on top the more likely it will fall relative to the other. So investors should not chase returns but instead play against them in the value/growth game.

This year in particular, value fell behind an additional 12% this year through July:

Here we compare SPDR Dow Jones Wilshire Large Cap Value ETF (AMEX:ELV) against its growth counterpart. The two split up the largest 750 US stocks with ELV taking firms with the low projected price-to-earnings ratio (P/E), projected earnings growth, price-to-book ratio, trailing revenue growth, trailing earnings growth, and high dividend yield. This is fairly typical among the broad-based plain vanilla US value ETFs which also includes these well-regarded funds.

We also believe in understanding the particularities of each business cycle, and in this age of banking crisis it is financial stocks which are driving the bus. It would be folly to ignore that value is much more heavily dosed with financial stocks than growth. In ELV, for instance, three banks still are ranked among the top ten holdings. Banks dragged down value in 2008, and when banks recover they will boost value's fortunes vs. growth. During one trading day in August, just three financial stocks accounted for more than one-third of an entire exchange's volume. All eyes are still focused on credit.

Many fine plain vanilla ETFs serve value. investors They are differentiated primarily by the size of firms they address:

  • iShares Russell 1000 Value ETF (NYSEArca:IWD): 1000 largest firms, .20%/year fees
  • iShares Russell 2000 Value ETF (NYSEArca:IWN): 1001-2000 largest firms, .25%
  • iShares Russell Midcap Value ETF (NYSEArca:IWS): 201-1000 largest firms., .25%
  • iShares S&P 500 Value ETF (NYSEArca:IVE): 500 largest firms, .18%
  • iShares S&P MidCap 400 Value ETF (NYSEArca:IJJ): 501 to 900 largest, .25%
  • iShares S&P SmallCap 600 Value ETF (NYSEArca:IJS): 901 to 1500 largest, .25%
  • SPDR Dow Jones Wilshire Large Cap Value ETF (AMEX:ELV): largest 750, .20%
  • SPDR Dow Jones Wilshire Mid Cap Value ETF (AMEX:EMV): 501-1000 largest, .25%
  • SPDR Dow Jones Wilshire Small Cap Value ETF (AMEX:DSV): 751-2500 largest, .25%
  • Vanguard Value ETF (AMEX:VTV): 750 largest firms, .11%
  • Vanguard Mega Cap 300 Value ETF (NYSEArca:MGV): 300 largest firms, .13%
  • Vanguard Mid-Cap Value ETF (AMEX:VOE): 301-750 largest firms, .13%
  • Vanguard Small-Cap Value ETF (AMEX:VBR): 751-1750 largest, .12%

The above products have reasonable fees (with Vanguard as usual leading the pack) and are based on well-regarded, modern, capitalization-weighted indexes. SPDR uses Dow Jones Wilshire indexes, while iShares deploys both Russell and S&P indexes, and Vanguard depends on MSCI. It is useful that most ETFs in each line are complementary and have no overlap. By sticking to one product line, an investor can overweight one asset class with clarity and precision. Among the exceptions is iShares' IWW which is a nearly total market product, Vanguard's VTV which is the sum of MGV and VOE, SPDR's ELV which overlaps other Wilshire ETFs in mid-cap and likewise iShares' IWS.

There are also funds through Rydex and Morningstar which claim to have the most accurate index methodologies available. They tend to be a little more expensive:

  • Rydex S&P 500 Pure Value ETF (NYSEArca:RPV), 500 largest firms, .35%
  • Rydex S&P MidCap 400 Pure Value ETF (NYSEArca:RFV), 501-900 largest, .35%
  • Rydex S&P SmallCap 600 Pure Value ETF (NYSEArca:RZV), 901-1500 largest, .35%
  • iShares Morningstar Large Value Index Fund (NYSEArca:JKF), .3%
  • iShares Morningstar Mid Value Index Fund (NYSEArca:JKI), .3%
  • iShares Morningstar Small Value Index Fund (NYSEArca:JKL), .3%

There are also several ETFs based on proprietary enhanced or fundamental indexes. These funds sometimes deliver higher returns, sometimes lower. They always charge higher fees.

Fundamental Value ETFs

  • First Trust Large Cap Value Opportunities AlphaDEX Fund (NYSEArca:FTA), .7%
  • Powershares Dynamic Large Cap Value Portfolio ETF (NYSEArca:PWV), .63%
  • Powershares Dynamic Mid Cap Value Portfolio ETF (NYSEArca:PWP), .63%
  • Powershares Dynamic Small Cap Value Portfolio ETF (NYSEArca:PWY), .63%

And finally there are short and leverage value ETFs suitable for speculative traders looking for a short-term play:

Short/Leverage Value ETFs

  • ProShares Ultra Russell 1000 Value ETF (NYSEArca:UVG), .95%
  • ProShares Ultra Russell 2000 Value ETF (NYSEArca:UVT), .95%
  • ProShares Ultra Russell MidCap Value ETF (NYSEArca:UVU), .95%
  • ProShares UltraShort Russell 1000 Value ETF (NYSEArca:SJF), .95%
  • ProShares UltraShort Russell 2000 Value ETF (NYSEArca:SJH), .95%
  • ProShares UltraShort Russell MidCap Value ETF (NYSEArca:SJL), .95%

Co-founder of indexfunds.com, author of two books on investing, and founder of ETFzone.com, Will has been writing on indexing issues for 8 years. He holds an MBA from the University of Texas at Austin.