And just like that, another star active manager bites the dust.
Earlier this month, one of the most respected mutual fund managers in history announced that he was stepping down after a tumultuous stretch that cast a long, red shadow over an otherwise illustrious career. Bill Miller, who has been the manger or co-manager of the Legg Mason Capital Management Value Trust since the fund started in the early 1980s, is stepping aside from the day-to-day management of the portfolio after a string of disappointing years shrunk the asset base of what was once a high-flying mutual fund that could seemingly do no wrong. Mason’s Value Trust beat the S&P 500 for a string of 15 straight calendar years between 1991 and 2005.
Recent years have not been so kind; Miller’s fund lost about 55% in 2008, and suffered some high profile blunders that included a massive loss in struggling camera firm Kodak. Those missteps have given additional ammunition to those who are convinced that active management is the quickest way to destroy value; in recent years Miller’s fund has lagged behind key benchmarks–and charged investors a hefty expense ratio of more than 1.7% to do so.
Miller is widely respected as one of the most successful stock pickers and money managers of the last several decades. But his fall from grace highlights the inability of even the most talented fund managers to consistently generate alpha, and makes a strong argument for indexing as a strategy. In fact, many of Miller’s departing rerouted their money into ETFs in recent years–and his high profile departure makes it likely that others will follow suit. With net expenses for the Value Trust ranging from 0.80% to 1.77% depending on the share class, one thing is for certain: a switch to one of the many ETF alternatives out there will reduce expenses paid by your clients considerably.
Below, we profile five interesting value ETFs that might be interesting alternatives to the Miller-less Value Trust:
Vanguard Value ETF (VTV)
For investors serious about reducing fees, Vanguard provides broad-based exposure to large cap value firms with an expense ratio of just 0.15%. A position in VTV could allow investors to shave close to 160 basis points off their large cap value positions. Investors can further lower their overall costs by trading VTV commission free through Vanguard accounts.
VTV tracks the MSCI US Prime Market Value Index, which seeks to measure the investment return of large-cap value stocks. Value stocks are characterized as having low price to earnings ratio and a high dividend yields. This fund is passively managed and utilizes the full-replication approach and has about 415 total holdings. VTV offers a significant amount of exposure to giant-cap equities, which account for approximately half of the fund’s total assets.
First Trust Large Cap Value AlphaDEX ETF (FTA)
This ETF is one of a number of funds that blur the line between active and passive management; FTA seeks to replicate an index that implements quant-based screens and ranking techniques to identify individual stocks with the greatest potential for capital appreciation. In other words, the fund managers and teams of analysts are replaced by an algorithm and a black box that is designed to derive alpha relative to traditional cap-weighted benchmarks–but at a much lower price and through a much more efficient vehicle.
The process for constructing FTA’s target index starts with ranking the stocks from the S&P 500 Value Index against all the stocks in the S&P 500 Index on growth factors including three, six and 12-month price appreciation, sales to price and one year sales growth, and separately on value factors including book value to price, cash flow to price and return on assets. From there, scores are tallied based on growth / value classifications, and a portfolio comprised of value stocks with the highest scores in constructed and weighted based on rankings.
FTA’s results have been impressive; the underlying index has blown away the S&P 500 Value Index over the last three years, and the fund boasts a relatively strong performance in a tough environment in 2011 as well [compare FTA vs. other value ETFs].
It is important to note that FTA’s expense ratio is 0.70%, which is relatively expensive compared to “plain vanilla” value ETFs such as VTV. But for those who buy in to the AlphaDEX methodology, this fund might be worth a bit more in fees. And, of course, FTA still represents a huge amount of savings compared to most active mutual funds.
Rydex S&P 500 Pure Value ETF (RPV)
The lineup of Pure Style ETFs from Rydex are a hidden gem in the ETF industry; while most style-focused investors gravitate towards funds that cast a wide net that results in a compromised style allocation, funds such as RPV offer an opportunity to target a select group of stocks that exhibit the strongest growth or value characteristics.
RPV is linked to the S&P 500/Citigroup Pure Value Index, an index that seeks to remove overlaps between growth and value stocks. This methodology makes RPV considerably more targeted than the S&P 500 Value Index Fund (IVE) which casts a wider net with the inclusion of hybrid growth and value stocks [compare the holdings of RPV and IVE].
RPV has a well-balanced but targeted portfolio of about 120 stocks; by comparison, IVE includes 340 individual names. That represents almost 70% of the S&P 500, and many of those components are also found in the growth counterpart. The Pure Value approach of RPV results in targeted exposure to only the large cap stocks that exhibit the strongest value characteristics, which might be an appealing methodology to those looking for a replacement for value-focused mutual funds.
Russell Low P/E ETF (LWPE)
The relatively new LWPE tracks the Russell U.S. Large Cap Low P/E Index, an index that is designed to select securities with low P/E ratios. This selection method is a common strategy among value investors who focus on companies that are trading at lower multiples relative to their prior level and/or their sector peers. The combination of this low P/E objective with the exchange-traded structure allows investors to achieve low cost, low maintenance exposure to a strategy that would otherwise require a lot of work and hefty fees.
LWPE offers exposure to 450 low P/E securities, with holdings heavily skewed towards the financial services and energy sectors. It is important to note that LWPE has a significant amount of exposure to giant cap companies, which account for approximately 39% of the fund’s total number of holdings.
PowerShares Fundamental Pure Large Value Portfolio (PXLV)
PXLV offers exposure to common equities of large value U.S. companies, but implements a unique methodology to select components and assign weightings. Instead of simply giving the largest weightings to the most valuable companies–the approach taken by cap-weighted products, PXLV is linked to an index that uses a selection methodology based on four fundamental measures of firm size: book value, cash flow, sales and dividends.
This indexing approach has potential advantages over most cap-weighted indexes in that it breaks the link between share price and weighting assigned, a feature that can result in the overweighting of overvalued stocks and the underweighting of undervalued ones, which is an inherit drawback of most cap-weighted ETFs. PXLV’s fundamental selection process also tempers the extent to which its underlying index can be influenced by irrational market factors that cause prices to deviate from their intrinsic value.
PXLV offers a low cost, low maintenance route to large cap value stocks, but with a strategy that does more than simply owning the market [see Do You Need A RAFI ETF?].
Disclosure: No positions at time of writing.
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