XSVM: Meteoric Growth Will Be Hard To Replicate

Vasily Zyryanov profile picture
Vasily Zyryanov
1.73K Followers

Summary

  • XSVM is a $484 million fund offering exposure to a peculiar amalgamation of seemingly antithetical factors, value with momentum.
  • Due to the index change in June 2019, most of its trading history is irrelevant.
  • The meteoric growth in the NAV earlier this year will be hard to replicate in 2022 or in the medium term.
  • Elevated turnover, high tracking error, mediocre dividends are amongst vulnerabilities. A neutral rating is a consequence.

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Adding yet another exchange-traded fund to my coverage list, today, we are discussing the Invesco S&P SmallCap Value with Momentum ETF (NYSEARCA:XSVM), an investment vehicle offering exposure to a peculiar amalgamation of seemingly antithetical factors, value with momentum, wrapped in a portfolio of small-size equities. Quite frankly, that is an intriguing combination. But does it actually bolster returns?

Despite the stresses that the pandemic has placed on the small-cap echelon, the iShares Core S&P SmallCap ETF (IJR) was relatively resilient in 2020, with a double-digit return, but XSVM failed to keep pace. Meanwhile, the blue chips (IVV) were well ahead.

Price returns. Created by the author using data from MorningstarPrice returns. Created by the author using data from Morningstar

This year, the tables have turned, and XSVM unit owners have been rewarded mightily, with a price return north of 51%, almost double the return of IVV as well as IJR, even despite the latter has also benefitted from the value/size rotation supercharged by vaccine optimism.

Is XSVM on the brink of another banner year? Not necessarily. I believe sterling 2021 is more of a deviation, and 2022 should be way less spectacular, as numerous headwinds from persistent inflation are clouding the outlook for the small-cap league, while tailwinds that undergirded its alpha returns earlier this year have mostly lost steam.

So even though XSVM has markedly robust historical returns (though mostly useless considering the index change in 2019), I have no strong bullish thesis for this vehicle owning to vulnerabilities discussed in greater detail below.

Investment strategy: mixing value, momentum, and size

Page 1 of the prospectus says XSVM tracks the smart-beta S&P 600 High Momentum Value Index. But there is something that can be easily missed. The fund had a totally different investment strategy before 21 June 2019, managing a portfolio of equities from the Russell 2000 Pure Value Index. Back then, it traded with a ticker PXSV. Invesco announced the decision to recalibrate the ETF lineup in the press release in March 2019, with a supplement to the prospectus available on the SEC website also published in the wake of this move.

It goes without saying that 'pure value' and value/momentum strategies have something in common. However, the one favors stocks that are almost certainly underappreciated regardless of their share price dynamics (they can creep lower for years and exhibit value-trap characteristics), while the latter attempts to combine sterling short-term returns with low multiples. Hence, the index change rendered performance before 21 June 2019 irrelevant, considering how profound is the difference between the benchmarks despite their small-size focus, so I ignored older data in the analysis, focusing only on the pandemic-torn 2020 and 2021.

After this necessary digression, we can proceed to a brief discussion of the methodology.

To select 120 top names deemed underpriced while also exhibiting robust momentum, the index provider uses the pool of securities from the S&P 600, a U.S. small-cap benchmark, as a starting point. Overall, the rules are rather close to those applied in the case of the S&P SmallCap 600 Value Index tracked by SLYV, which I discussed in the September note, except for the momentum screen added, which, in my view, allows to more or less successfully identify value traps and thus ward off the damage to NAV that can happen in case chronic laggards continue falling.

Just three multiples are considered, namely Book/Price, Earnings/Price, and Sales/Price. They are mixed to arrive at a value score. After 240 with the highest VSs are whittled down and then ranked using momentum score, 120 are selected for the index, with weights assigned depending on the value scores.

The index is rebalanced in June and December. More details on the process can be found in the methodology document.

Examining factor exposure: an abundance of value, but momentum not as robust

As of December 14, the fund oversaw a portfolio of 115 stocks and REITs, with the top ten accounting for just around 17%, so the level of diversification is close to excellent here. As of my calculations, the weighted-average market capitalization of the holdings stood at $1.98 billion, while the median was around $1.68 billion. This is a solid argument illustrating the fund does not have a top-heaviness problem. On the negative side, standard deviation, tracking errors, annualized volatility, and turnover are so high that the ETF has the F Risk grade, the worst possible.

Approximately 29.5% of the net assets are allocated to the financial sector (including a few mortgage REITs, insurance companies, etc.), with consumer discretionary in second place (almost 22%). Here are the key 25 financial names from the portfolio, with the Quant data, where available.

Created by the author using data from the fund and Seeking Alpha

Created by the author using data from the fund and Seeking Alpha

Now, an essential question. Is XSVM a value ETF? Mostly yes, but with caveats.

Instead of focusing on ratios like P/E, P/B, or P/S, we can opt for a more sophisticated score that contributes to the Quant rating of a company on Seeking Alpha - the Valuation grade. So names with at least B- VGs have close to 75% weight in the fund, an impressive level, and I can say without any hesitation that XSVM is truly a value-focused fund, at least in the current iteration. However, it still has exposure to imperfectly valued companies (D grades), ~7%.

Below are the most undervalued stocks from XSVM:

Created by the author using data from the fund and Seeking Alpha

As I have illustrated in a few of my notes this year, the small-cap league offers a panoply of opportunities for value investors, with the risks related to poor profitability also being elevated. And the value/momentum ETF again illustrates that vividly. Only around 41% of its portfolio is allocated to stocks with solid Profitability grades; most of the large-cap funds I have assessed to date have an over 80% allocation to highly profitable companies.

Next, exposure to growth is relatively large, ~46%.

The dividend factor is mostly a disappointment, as 54 companies (~47% weight) do not pay a dividend. No coincidence XSVM has a yield below 1%.

And ultimately, momentum. Does the XSVM portfolio encompass top performers from the small-cap echelon?

The fund itself has a B- Momentum grade, which speaks for itself. Acceptable, but not perfect. But if we take a look at the metrics influencing the rating, we will notice that one-year performance is the key contributor, while more recent returns are dreadful. Why? The capital rotation has bolstered its one-year performance but then has lost steam.

Source: Seeking Alpha

Speaking about the holdings, ~61% have Momentum grades of at least B-. There are a few stellar performers in the mix, with Veritiv (VRTV) that has gained 443% YTD being the winner. But there are only 7 stocks (~6.8% weight) with positive one-month returns, while 39 names lost more than 10% since mid-November. The table below shows the 25 most afflicted stocks (and yes, VRTV is in the group).

Created by the author using data from the fund and Seeking Alpha

Created by the author using data from the fund and Seeking Alpha

The verdict? XSVM's strategy has delivered massive returns earlier this year, capitalizing on momentum, which, in turn, was propped up the capital rotation. Alas, the rally has sputtered.

Final thoughts

In essence, XSVM offers relatively expensive exposure to the reshuffled version of the IJR portfolio that I have analyzed just recently, with equities having unsatisfying multiples and lackluster momentum removed, and, in theory, the lower risk that value traps would percolate into its equity mix, jeopardizing returns.

The rather unorthodox combination of small size, low multiples, and momentum has earned a great deal of investor attention this year, as XSVM has been on a tear, with returns well outpacing the market, as well as the S&P 600 ETF. However, the YTD price chart shows that most of its gains were achieved in spring, and since then, it has been trading rangebound, except for November.

Chart
Data by YCharts

Now, doubts are rising. My take is that the meteoric growth in the NAV earlier this year will be hard to replicate in 2022 or in the medium term. With a 75% turnover and 39 bps expense ratio, XSVM is a Hold.

This article was written by

Vasily Zyryanov profile picture
1.73K Followers
Vasily Zyryanov is an individual investor and writer.He uses various techniques to find both relatively underpriced equities with strong upside potential and relatively overappreciated companies that have inflated valuation for a reason.In his research, he pays much attention to the energy sector (oil & gas supermajors, mid-cap, and small-cap exploration & production companies, the oilfield services firms), while he also covers a plethora of other industries from mining and chemicals to luxury bellwethers.He firmly believes that apart from simple profit and sales analysis, a meticulous investor must assess Free Cash Flow and Return on Capital to gain deeper insights and avoid sophomoric conclusions.While he favors underappreciated and misunderstood equities, he also acknowledges that some growth stocks do deserve their premium valuation, and its an investor's primary goal to delve deeper and uncover if the market's current opinion is correct or not.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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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