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A Deeper Dive Into Value Vs. Growth

Jul. 06, 2018 9:52 AM ETBHF, IAK, KIE, LNC, MET, PFG, PRU, RDVY, SDOG, SPYV, IWD, IWF9 Comments
ETF Global profile picture
ETF Global


  • Value Funds are underperforming and trading at low multiples when traditional investment logic says they should be outperforming.
  • Life Insurance stocks are especially cheap and they could be signaling more trouble ahead.
  • They have a small impact on the overall market but a much larger one on several popular dividend income funds.

"The first step in avoiding a trap is knowing of its existence"

- From Dune by Frank Herbert

If there’s one thing Americans can agree on here at the halfway mark of 2018 it’s that they feel more divided now than at any point in the last four decades and on any possible topic you can imagine. Politics, the national anthem, and all female reboots are all topics to be avoided at family functions but the one divide that no one can safely ignore is value versus growth and with two quarters of the year now in the books, growth is clearly eating value’s lunch.

As of July 2nd, there’s an almost 1000 basis point spread between the YTD returns for the iShares Russell 1000 Growth (IWF) and iShares Russell 1000 Value (IWD) and that can have profound implications for exchange traded funds in the second half of 2018.

We collect and score hundreds of different data points on thousands of ETFs including various price multiples and dividend yields although they can be meaningless without a point of comparison. Some compare a fund to the broader market while others use that data looking for cheaper funds within a sector, but we also rank every equity compared to prior multiples to determine whether a fund is trading above or below its historical averages, making it easier to do a bit of trend spotting. Not surprising to anyone is that at the top you’ll find nothing but style-box growth funds and a handful of tech and consumer discretionary ETFs full of the names that make up the growth space and have absolutely crushed it over the last two years.

We’re more interested in why value funds, typically heavily weighted towards financials, have been lagging so far behind when most investment textbooks would tell you

This article was written by

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Analyst’s 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.

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Comments (9)

Thanks for the useful analysis.
PRU and MET could become more interesting following further drops.
ETF Global profile picture
First off, thank you for taking the time to read the article and ask follow-up questions. Our focus has been on trying to educate investors on how ETF’s work and impact the broader market. A big part of that is focusing on individual names and sectors and while the net takeaway on Principal Financial Group (PFG) was that the market might be right when it comes to how heavily discounted it is, the larger focus was on how that impacts certain dividend-oriented funds.

Focusing on bonds, you’re right in that the rising rate environment has begun to ding PFG’s bond portfolio of older holdings thanks to their lower coupons although PFG is dealing with other issues including widening spreads. Their portfolio is largely geared towards investment grade corporate bonds where spreads have widened the most recently thanks to a combination of strong new issuance without a strong increase in demand (www.bloomberg.com/...).

Part of that could just be investors anxious about whether rates will continue to rise but decreasing credit quality could also be a concern given how late we are in the market cycle and how much debt levels have risen overall. In the meantime, PFG only has a relatively small amount of bonds maturing in the near-term so the opportunities to reinvest in higher-paying bonds are relatively small. And while they wouldn’t incur any capital losses if they bought the bonds at par and held them to maturity, unrealized losses will still show up in comprehensive income although whether that gets noticed by anyone just looking at the headlines is anyone’s guess.

The bigger issue is their retirement income business and you hit the nail on the head with PFG’s asset management arm. The original focus of the piece was going to be more on the DOL’s Fiduciary rule and how it impacted both insurers, asset managers and broker/dealers. Generally, it seems that independent firms have done better while more those more oriented towards specific products, like in-house mutual funds or annuities have lagged. Broker/dealers have largely shrugged it off, in fact you can see the difference when you compare the returns of the iShares U.S. Insurance ETF (IAK) to the iShares U.S. Broker-Dealers & Securities Exchanges ETF (IAI) after the 2016 election. IAI has strongly outperformed IAK and is positive even in 2018 when the broader financials are struggling. PFG’s asset management team contributed a little more than 22% of the company’s operating revenue in the first quarter, about on par with what it provided in 1Q 17, although that figure grew only by around 10% and is still less than half of what they earn from their retirement income solutions group. Given the fee compression in mutual funds along with the elimination of loads and trailing fees, the opportunities to continue growing that contribution in the future might be more limited.

Hope that helps answer you questions.
AspiretoRetire profile picture
Thanks for the detailed response. Much food for thought.
AspiretoRetire profile picture
As a long investor in PFG, I read you piece with interest. However, I see some problems with it and would appreciate any response to the following critique.

First, you assume that investment income should be going up in a rising rate environment, but the value of its bond portfolio has dropped - so maybe there is a hidden problem . . . The answer is obvious. Interest income should be going up, but who in their right mind would expect that the value a portfolio of older bonds would do anything but drop as rates rise? How much does increased interest income offset the decreased value of the portfolio? We do not know.

Also, the bond portfolio losses are unrealized paper losses that matter most if PFG has to sell the bonds. They don’t. That means that the bonds they have will continue generating positive interest income, just not as much as new bonds. That makes the whole issue a big “so what,” not something that affects revenue or cash flow.

Finally, although I have given up trying to predict long-term interest rates, I do think there is no small chance that LT bond prices will recover a bit this fall if the Fed pulls back on its plans to raise rates. That may happen for a number of reasons. If so, the size of the unrealized losses going forward is difficult to predict.

A bigger issue is that PFG is a diversified global financial firm, not just an insurer. The market values them like an insurer, certainly. But how much does the value of the bond portfolio matter to PFG overall? I don’t know from the article.

What am I missing here?
Mili21 profile picture
Based on 3 years Revenue & Net Income growth, just past Thursday, I bought PRU between (over MET).
Also, PRU has a better dividend growth (& prospects) over MET.
BTW, what are your thoughts about AFL?
ETF Global profile picture
We don't have much of an opinion on Aflac. ETF Global is data provider and ETF research firm so our focus is typically on explaining ETF trends and often the best way to do that is by diving into some of the individual holdings that are driving the trend. In this case, our analysts had noted that insurance funds were trading at low price multiples relative to their own history and certain life insurers were even cheaper which required them to do some digging in the financials.
Added to PRU myself, would add to MET too if I had the spare cash
Interesting explanation on the workings/failings of the insurance industry. Interesting that the “fiduciary factor” would outweigh the “rising rate factor.” So I will have to update my sector totals for VYM, QDEF, and RDIV to see how financial they are now. I normally list out their sector percentages (with the help of Morningstar’s excellent sector breakdowns) to make sure I’m not just TOO skewed. (Insert joke here.). Last time VYM and QDEF were over 10% but RDIV was nearly devoid. Suppose I better wait another month until summer rebalancing is done. Good article!

Thanks for the informative analysis.

Recently long PRU.

Retired income/dividend-growth investor
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