VFVA: Riskier Than Other Value ETFs (BATS:VFVA)

VFVA strategy and portfolio

The Vanguard U.S. Value Factor ETF (BATS:VFVA) has 721 holdings, a distribution yield of 1.85%, and a total expense ratio of 0.13%. It is actively managed and doesn’t track a specific index. As explained in the prospectus by Vanguard, a quantitative model is used to “generate higher returns relative to the broad U.S. equity market by investing in stocks with relatively lower share prices relative to fundamental values as determined by the advisor.” Its turnover in the last fiscal year represent 43% of average asset value, which is quite high.

VFVA invests almost exclusively in U.S. companies (98.5% of asset value), in all size segments, from large companies to micro-cap.

VFVA is much cheaper than its benchmark the Russell 3000 index (IWV), as shown by the next table reporting valuation ratios.

Source: Fidelity

VFVA currently holds 721 stocks. The top 10 holdings (listed below with valuation ratios) represent about 9% of the portfolio value and the heaviest position weights about 1%. As a consequence, the risk related to any individual stock is very low.

Ratios: Portfolio123

The top three sectors are financials (21.7%), consumer discretionary (18.7%) and industrials (15.9%). Other sectors are below 10%. Compared to the Russell 3000, the fund underweights technology, healthcare, and it almost ignores real estate and utilities. It overweights all other sectors.

Since VFVA inception (02/13/2018), VFVA has lagged its benchmark by 2.3 percentage points in annualized return. Moreover, it shows a much higher risk in drawdown and volatility (standard deviation of monthly returns).

Comparing FVAL with other value ETFs

The next table compares FVAL performance since its inception with five large and mid cap value ETFs by different issuers and based on different underlying indexes.

VFVA is in the middle of the pack in return, but it is the riskiest fund of the list. Volatility is significantly higher and the maximum drawdown is deeper by 10 to 13 percentage points. To put this in perspective, it represents an additional loss of $1000 to $1300 relative to its competitors for a $10000 position. The Fidelity Value Factor ETF (FVAL), reviewed here, is the best performer of the list.

The weaknesses of most value ETFs

What does this table say about VFVA strategy? The fund is actively managed and the quantitative model is not disclosed. However, the fact that VFVA has a return and a sector composition similar to other value ETFs suggest that it has the same shortcomings. The first one is to classify all stocks on the same criteria. It means valuation ratios are considered comparable across sectors. Obviously, they are not: you can read my monthly dashboard here for more details about this topic.

A consequence is to privilege sectors where valuation ratios are naturally cheaper, especially financials. It explains why the financials sector has such a heavy weight in the VFVA portfolio, and why technology is underweight. Technology is a sector with large intangible assets (massive R&D, large user databases, etc…), which are not correctly reflected by valuation ratios.

The second shortcoming comes from the price/book ratio (P/B), which adds some risk in the strategy. Speaking probabilities, a large group of companies with low P/B contains a higher percentage of value traps than a same-size group with low price/earnings, price/sales or price/free cash flow. Statistically, such a group will also have a higher volatility and deeper drawdowns in price.

The next table shows the return and risk metrics of the cheapest quarter of the S&P 500 (i.e.125 stocks) measured in price/book, price/earnings, price/sales and price/free cash flow. The sets are reconstituted annually between 1/1/1999 and 1/1/2022 with elements in equal weight.

Data calculated with Portfolio123

This also explains my choice of not using P/B in my Dashboard List model (more info at the end of this post).

Takeaway

VFVA is an actively managed value fund using a proprietary quantitative model. It has failed to outperform its benchmark in four years of existence. Price history is too short to judge it relative to a broad index, but it is long enough to compare it to same-style ETFs. The result of the comparison is underwhelming: VFVA is in the average regarding return, and much worse regarding risk.

Even if its strategy is not disclosed, sector composition and volatility point to two shortcomings. First, it probably ranks value stocks regardless of their sectors, hence a high exposure to financials. Second, price/book (or another book-based ratio) probably is a major factor of the model, increasing the risk of buying value traps, hence volatility and drawdowns.

An efficient value model should compare stocks in comparable sets (sector, industry), like I do in the Dashboard List since 2015. This model uses three valuation metrics, excluding price/book. Moreover, a simple ROE rule helps filter out some value traps and normalize the number of components.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.