Seeking Alpha
Deep value, long/short equity, event-driven, research analyst
Profile| Send Message|
( followers)  

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

VTV

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%

MGV

Vanguard Mega Cap 300 Value Index ETF

0.12%

2.69

131038

55.6%

SCHV

Schwab U.S. Large-Cap Value ETF

0.13%

5.78

139813

60.7%

IVE

iShares S&P 500 Value Index

0.18%

2.10

126208

34.1%

IWD

iShares Russell 1000 Value Index

0.20%

1.86

127830

42.9%

IWX

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 (NYSE: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

PEO

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

ADM

Archer Daniels Midland Co.

Farm Products

1.08

13.24

3.7

CVS

CVS Caremark Corporation

Drug Stores

1.5

17.16

3.7

GLW

Corning Inc.

Diversified Electronics

0.99

7.77

3.5

HUM

Humana Inc.

Health Care Plans

1.79

10.94

3.4

LYB

Lyondell Basell Industries NV

Specialty Chemicals

1.82

8.23

4.1

NOC

Northrop Grumman Corp.

Aerospace/Defense

1.47

8.04

3.1

SNDK

SanDisk Corp.

Semiconductor- Memory Chips

1.56

11.36

3.7

SPLS

Staples, Inc.

Specialty Retail, Other

1.46

10.92

4.1

VLO

Valero Energy Corporation

Oil & Gas Refining & Marketing

0.85

6.47

4.0

BHI

Baker Hughes Incorporated

Oil & Gas Equipment & Services

1.4

12.85

3.4

COP

ConocoPhillips

Major Integrated Oil & Gas

1.45

8.01

3.1

CVX

Chevron Corporation

Major Integrated Oil & Gas

1.76

7.95

4.5

MRO

Marathon Oil Corporation

Oil & Gas Refining & Marketing

1.39

13.82

5.4

MUR

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.

Source: Clever Large Cap Value Investing: A Better Approach Than Choosing From Available ETFs