A simple definition of value investing is the implementation of a strategy that selects stocks that are trading below their intrinsic values. Decades of academic research support the notion that, particularly over long time horizons, value is one of the most efficacious investment factors.While an array of value strategies have performed admirably over the course of the current U.S. bull market, the factor has languished in recent years. For the three-year period ending Oct. 8, 2018, the Russell 1000 Value Index is up 39.70 percent, paling in comparison to the 63.80 percent returned by the Russell 10000 Growth Index over the same period. That underscores the point that while a particular factor may be rewarding over the long haul, factor leadership varies from year-to-year .Despite value's recent struggles, related funds remain popular with advisors and investors. Several of the largest single-factor exchange traded funds (ETFs) are value funds and some of those products are among the largest ETFs of any variety.With value experiencing an uncharacteristically long dry spell relative to growth and momentum, reviewing value funds could be a solid idea. The JPMorgan U.S. Value Factor ETF ( JVAL ) is a newer though still credible competitor in the value ETF fray.
Inside JVAL's Methodology
JVAL, which is just weeks a way from its first anniversary, targets the JP Morgan US Value Factor Index. That benchmark “is comprised of US securities selected from the Russell 1000 Index and uses a rules-based risk allocation and factor selection process developed in conjunction with J.P. Morgan Asset Management,” according to FTSE Russell
. “The index is designed to reflect a sub-set of US securities selected for their factor characteristics. The index selects constituents based on diversified measures of their valuation without undue concentration in individual securities.”Avoiding concentration risk at the individual security level is pivotal in providing diversification, one of the key benefits of broad market funds. With single-factor strategies, sector treatment is also crucial and serves to explain some of the out-performance offered by JPMorgan U.S. Value Factor ETF
over some well-known value benchmarks.Currently, “old school” value funds and indexes are heavily allocated to the energy and financial services sectors. The combined weights to those sectors among the S&P 500 Value Index and the Russell 1000 Value Index are, as of Oct. 8, 2018, 38.54 percent and 34 percent, respectively.One way of looking at the scenario is that traditional value strategies are heavily exposed to sectors that are taking turns lagging the broader market in significant fashion. Last year, energy was the worst-performing sector in the S&P 500. This year, despite three interest hikes from the Federal Reserve, financial services stocks are posting disappointing returns.Related: Mid Caps Married With a Multi-Factor Strategy
Related: An Appropriate Time to Make a Quality Query
Sector weights matter. The JPMorgan U.S. Value Factor ETF
allocates 24.40 percent of its combined weight to the financial services and energy sectors, a significant underweight on a combined basis relative to the S&P 500 Value Index and the Russell 1000 Value Index.JVAL is also significantly overweight technology, a sector not often viewed as a value destination, compared to those other value indexes. As of October 8, 2018, JVAL's technology weight
is 20.50 percent compared with an average tech weight of 8.03 percent for the S&P 500 Value Index and the Russell 1000 Value Index.As the chart below indicates, JVAL's sector allocations are creating meaningful out-performance of competing value indexes over the past 10 months.
With its overweight (compared to other value strategies) in tech stocks, JVAL offers another advantage: exposure to profitable companies, many of which are considered quality names
. While JVAL is designed to be a value fund, exposure to the quality factor serves as a factor diversifier.“The major benefit of having a portfolio that is exposed to both value and profitability is that these two strategies can diversify each other,” said Morningstar
. “Value strategies purchase stocks of companies that are on the ropes, while strategies based on measures of profitability tend to invest in firms with rosier prospects. Therefore, when one strategy is doing poorly, the other is likely performing well.”