When one thinks of "value" stocks, the immediate impression is that of a more conservative, undervalued stock that typically offers a higher yield. The SPDR S&P 500 Value ETF (NYSEARCA:SPYV), for example, has a P/E ratio of 16.3 and a dividend yield of 2.5%, compared to the P/E of 18.3 and dividend yield of 2.1% for the SPDR S&P 500 Trust ETF (NYSEARCA:SPY). It's a simplistic example, but the trend holds true for large caps, mid caps and small caps alike.
Deep value, however, should be considered riskier. It's really more of a turnaround play than a pure value play. Some of these turnaround stories play out, and some of them get worse before they get better (if they get better at all). While the P/E ratio for a deep value portfolio may be especially low, part of the reason for that could be that many stocks within the fund may have been beaten down by the economic environment.
The Deep Value ETF (NYSEARCA:DVP) presents an intriguing possibility for retirement income investors. While most retirees likely always look for ways to boost their income, they must do so in a way that doesn't put their overall portfolio in an excessively risky position. The fund currently has a dividend yield of over 5.5% which, in a vacuum, sounds good, but does the fund's overall risk level make it a wise addition to a conservative retirement portfolio?
Deep value stocks were beaten up for much of the last three quarters of 2015 as energy and basic materials stocks - two sectors that likely got a lot attention as turnaround plays - got walloped. The Deep Value ETF dropped roughly 10% on the year, significantly trailing the S&P 500. However, the fund has rebounded in 2016, outpacing the S&P 500 by over 300 basis points, while also beating both mid caps and small caps.
Before proceeding any further, there are a few factors which should be discussed right off the bat before we even discuss whether or not DVP fits in a broader portfolio.
The first is the fund's expense ratio. At 0.80%, the costs associated with this fund are higher than average. Some specialty and niche funds can get away with a higher expense ratio due to the inherent nature of the fund and what it's investing in. DVP, however, invests primarily in domestic mid-cap and large-cap companies, making this expense ratio more unreasonable.
Second is the tradeability of the fund's shares. DVP has roughly $70 million in total assets, but only trades around 6,000-8,000 shares daily. The thinly traded nature of this fund will make larger share purchases more challenging, while trading costs and spreads will likely be high.
Perhaps not surprisingly, the Deep Value ETF has loaded up on beaten-down energy and basic materials stocks.
Nearly half of the portfolio's assets reside in these two sectors, clearly betting on a rebound in commodities and energy prices. So far in 2016, it's got it, as spot prices for oil as well as commodities like gold and iron ore have rallied sharply, helping to push this fund higher.
Financials and healthcare are the notable underweights in this fund. These two sectors account for nearly 30% of the S&P 500, but comprise just 3% of the Deep Value ETF's total assets, with nothing invested in healthcare at all.
Market Cap Breakdown
According to the fund's fact sheet:
"The Index is comprised of 20 undervalued dividend paying stocks within the S&P 500 Index with solid balance sheets, positive earnings and strong free cash flow."
The fact that the portfolio only holds roughly 20 stocks makes it riskier due to its concentration, but it also tends to take its names from the smaller end of the S&P 500.
About two-thirds of the Deep Value ETF's assets qualify as mid caps, with most of the remaining assets in large caps. This is quite a difference between the two funds, and while I make most of my comparisons to the S&P 500, one could easily compare this fund to the SPDR S&P MidCap 400 ETF (NYSEARCA:MDY) and be justified.
Risk Factors and Correlations
As mentioned previously, the fact that DVP is at least in part making bets on turnarounds makes it riskier than average. While the fund is still too young to get a complete risk assessment, we do have some data to work with.
An examination of the one-year standard deviation of returns suggests this ETF is twice as risky as the S&P 500.
The fund's beta seems to tell a similar story, as ETF Database quotes a beta of 1.85.
A high beta in and of itself isn't necessarily a bad thing. How the fund interacts with other stocks and funds in a portfolio could end up lowering overall portfolio risk. I checked two different ETF correlation tools to see how the Deep Value ETF correlated with the S&P 500. One site calculated a three-month correlation factor of 0.53, while the other quoted a value of 0.70.
Those correlation values aren't all that different from stocks' correlation with real estate, an asset class that many would generally suggest should be a part of a retirement portfolio.
Dividend consistency would likely be a concern with the Deep Value ETF. A yield of 5% or more is nice, but inconsistent quarterly payments make it less reliable and appropriate for a retirement portfolio.
Quarterly dividends for this fund averaged around $0.15 per share for the first several quarters, before jumping to $0.44 in Q4 2015 and again to $0.50 in Q1 2016. Whether this higher dividend is the new norm or just an aberration remains to be seen. One mutual fund counterpart, the Towle Deep Value Fund (MUTF:TDVFX), pays just short of 4%, so the higher dividend may be the expectation going forward.
While the 5% dividend is certainly enticing, and the diversification benefits could help offset some overall risk, it's difficult to recommend adding a fund to a retirement portfolio that is significantly risky, thinly traded and may pay an inconsistent quarterly dividend.
For those who want to live a little more dangerously, this fund probably warrants no more than a 10% allocation and, ideally, closer to 5%. It might be prudent to wait a few more quarters to get a sense of how steady the dividend will be. For now, though, retirees may want to avoid this fund for now with an eye towards possibly adding it at some point in the future.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.