Surprisingly, low fee open-end mutual funds and exchange-traded funds (ETFs) in the large cap value category are not compelling. Instead, retail investors should consider direct investment in large cap value stocks. Furthermore, retail investors who have longer time horizons ought to consider a discounted closed-end fund alternative for large cap growth exposure.
Fund Evaluation
Investors seeking exposure to large cap value stocks have many funds to choose from. They should select funds using the following criteria:
Low expense ratios. The less that investors pay in fund-level fees, the more they keep.
Holdings with low price-to-book ratios. These funds should have a mix of value and growth holdings that leads to a mid-range price-to-book ratio average for the portfolio.
Holdings with large cap market capitalizations. These funds should hold large cap firms to gain the expected exposure.
Financially strong holdings. This is the fly in the ointment! Funds should be biased towards stocks with stronger financial positions that can weather bad times. Funds with more holdings which score as "safe" according to the Altman Z-score metric are preferable to funds with weaker holdings.
A collection of large cap value funds with expense ratios under 0.25% were evaluated based on their top 25 holdings. Key attributes of these funds and their holdings are listed below:
Ticker | Fund | Expense Ratio | Avg P/B | Avg Market Cap ($ Millions) | "Safe" Weight |
Vanguard Value ETF | 0.12% | 2.69 | 131038 | 55.6% | |
VVIAX | Vanguard Value Index Adm | 0.12% | 2.69 | 131038 | 55.6% |
VVISX | Vanguard Value Index Signal | 0.12% | 2.69 | 131038 | 55.6% |
Vanguard Mega Cap 300 Value Index ETF | 0.12% | 2.69 | 131038 | 55.6% | |
Schwab U.S. Large-Cap Value ETF | 0.13% | 5.78 | 139813 | 60.7% | |
iShares S&P 500 Value Index | 0.18% | 2.10 | 126208 | 34.1% | |
iShares Russell 1000 Value Index | 0.20% | 1.86 | 127830 | 42.9% | |
iShares Russell Top 200 Value Index | 0.20% | 1.86 | 127830 | 42.9% |
None of these funds are compelling buys since they achieve value by taking on firms with weaker balance sheets.
Quick, Easy, and Better Large Cap Value
One way to gain large cap value was discovered in a prior article which reviewed closed-end funds trading at a discount. The Petroleum Resources Corporation (PEO) is a closed-end fund that trades at a 13.49% discount and pays a 11.11% distribution yield. It has a natural resources-specific investment theme but its holdings feature large cap value stocks and have better Altman Z-scores:
Ticker | Fund | Expense Ratio | Avg P/B | Avg Market Cap ($ Millions) | "Safe" Weight |
Petroleum Resources Corp. | 0.64% | 2.50 | 55683 | 74.6% |
Investors could also consider investing in large cap stocks directly as an alternative to investing through low-fee ETFs and open-end mutual funds. Here is a list of large cap stocks with price-to-book ratios under 1.86 which qualify as "safe" using the Altman Z-score:
Ticker | Company | Industry | P/B | P/E | Altman Z-score |
Archer Daniels Midland Co. | Farm Products | 1.08 | 13.24 | 3.7 | |
CVS Caremark Corporation | Drug Stores | 1.5 | 17.16 | 3.7 | |
Corning Inc. | Diversified Electronics | 0.99 | 7.77 | 3.5 | |
Humana Inc. | Health Care Plans | 1.79 | 10.94 | 3.4 | |
Lyondell Basell Industries NV | Specialty Chemicals | 1.82 | 8.23 | 4.1 | |
Northrop Grumman Corp. | Aerospace/Defense | 1.47 | 8.04 | 3.1 | |
SanDisk Corp. | Semiconductor- Memory Chips | 1.56 | 11.36 | 3.7 | |
Staples, Inc. | Specialty Retail, Other | 1.46 | 10.92 | 4.1 | |
Valero Energy Corporation | Oil & Gas Refining & Marketing | 0.85 | 6.47 | 4.0 | |
Baker Hughes Incorporated | Oil & Gas Equipment & Services | 1.4 | 12.85 | 3.4 | |
ConocoPhillips | Major Integrated Oil & Gas | 1.45 | 8.01 | 3.1 | |
Chevron Corporation | Major Integrated Oil & Gas | 1.76 | 7.95 | 4.5 | |
Marathon Oil Corporation | Oil & Gas Refining & Marketing | 1.39 | 13.82 | 5.4 | |
Murphy Oil Corporation | Oil & Gas Refining & Marketing | 1.36 | 16.29 | 4.2 |
Investors could buy these stocks to create a portfolio consisting entirely of "safe" stocks with low p/b ratios. This would require 14 separate trades.
A hybrid approach to portfolio construction would involve purchasing PEO and the first eight stocks on this list. (The last six stocks are involved in Oil & Gas and would be redundant with PEO's holdings.) This method would replace oil and gas stocks with PEO while retaining the industry diversification of the other stocks on this list. All in all, this approach would require nine trades. The resulting combination of PEO and stock holdings would be purchased at a smaller discount (thanks to PEO) and would include between 74.6% and 100% stocks with "safe" Altman Z-scores.
Please read the article disclaimer.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
