XSVM: Not Better Than A Small Cap Benchmark

Summary

  • XSVM implements a value and momentum strategy in the S&P SmallCap 600 index.
  • Over one third of its asset value is in financials.
  • It has slightly lagged the parent index since inception.
  • The underlying index has two shortcomings.
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Small Cap write on sticky notes isolated on Office Desk. Stock market concept

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Strategy and portfolio

The Invesco S&P SmallCap Value with Momentum ETF (NYSEARCA:XSVM) has been tracking the S&P 600 High Momentum Value Index since March 2005. It has 120 holdings, a distribution yield of 1.5% and an expense ratio of 0.39%.

As described in the prospectus by Invesco, stocks in the parent index S&P 600 are given a value score based on three ratios: book-value-to-price, earnings-to-price, and sales-to-price. Then, a momentum score is given to the 240 stocks with the highest value score. It is calculated from the 12-month return excluding the most recent month. The 120 stocks with the highest momentum score are included in the S&P 600 High Momentum Value Index and weighted by value score. The index and ETF holdings are reconstituted and rebalanced twice a year.

As expected from a value ETF, aggregate valuation ratios of XSVM are much lower than for the parent index S&P 600, tracked by the iShares Core S&P Small-Cap ETF (IJR).

XSVM

IJR

Price/Earnings TTM

8.1

14.02

Price/Book

1.2

1.9

Price/Sales

0.48

1.04

Price/Cash Flow

5.85

10.53

Source: Fidelity

XSVM currently holds 119 stocks. It intends to fully replicate the underlying index, but it may not hold all the 120 constituents depending on trading constraints like float and liquidity. The top 10 holdings represent about 19% of the portfolio value. The next table lists their weights and valuation ratios.

Ticker

Name

Weight%

P/E ttm

P/E fwd

P/Sales

P/Book

P/FCF

Yield

ZEUS

Olympic Steel Inc.

3.15

2.76

3.93

0.15

0.82

N/A

1.10

PBF

PBF Energy Inc.

2.87

14.95

5.25

0.12

1.94

8.71

0

TWI

Titan International Inc.

1.90

16.62

10.01

0.52

4.06

N/A

0

RYAM

Rayonier Advanced Materials Inc.

1.67

4.68

N/A

0.20

0.37

5.82

0

TMST

TimkenSteel Corp.

1.64

5.82

5.22

0.83

1.62

6.29

0

ANDE

Andersons Inc.

1.57

12.57

13.20

0.09

1.10

N/A

2.06

ODP

The ODP Corporation

1.51

N/A

9.35

0.23

1.36

9.74

0

FDP

Fresh Del Monte Produce Inc.

1.51

17.83

16.75

0.26

0.61

N/A

2.55

SCSC

ScanSource Inc.

1.50

10.12

9.08

0.28

1.17

63.86

0

BCC

Boise Cascade Co.

1.50

3.51

4.20

0.36

1.85

6.52

0.63

Weights: Invesco; Ratios: Portfolio123

The heaviest sector is by far financials (34.15% of asset value), followed by consumer discretionary (15.12%), industrials (14.57%) and materials (12.13%). Other sectors are under 6%. Compared to the parent index, XSVM overweights a lot financials and materials. It underweights healthcare, technology, real estate and ignores utilities.

XSVM sectors

XSVM sectors (chart: author; data: Fidelity)

Historical performance

Since inception, XSVM has slightly underperformed IJR. However, the difference in annualized return is not significant (8 bps). Risk metrics are similar for both funds (drawdown and volatility).

Total Return

Annual Return

Drawdown

Sharpe ratio

Volatility

XSVM

332.28%

8.88%

-61.61%

0.47

22.38%

IJR

337.45%

8.96%

-59.77%

0.5

20.04%

Data calculated with Portfolio123

The next chart plots the equity value of $100 invested in XSVM and IJR since inception.

XSVM vs. IJR

XSVM vs. IJR (Chart: author; Data calculated with Portfolio123)

XSVM has slightly lagged the benchmark until 2018, then it has outperformed it and is now almost tie for the available price history.

Comparison with my Dashboard List model

The Dashboard List is a list of 80 stocks in the S&P 1500 index, updated every month based on a simple quantitative methodology. All stocks in the Dashboard List are cheaper than their respective industry median in Price/Earnings, Price/Sales and Price/Free Cash Flow. After this filter, the 10 companies with the highest Return on Equity in every sector are kept in the list. Some sectors are grouped together: energy with materials, communication with technology. Real estate is excluded because these valuation metrics don't work well in this sector. I have been updating the Dashboard List every month on Seeking Alpha since December 2015, first in free-access articles, then in Quantitative Risk & Value.

The next table compares XSVM performance with the Dashboard List model on the same period (since 11/21/2005), with a tweak: the list is reconstituted twice a year like XSVM underlying index.

since inception

Total Return

Annual Return

Drawdown

Sharpe ratio

Volatility

XSVM

332.28%

8.88%

-61.61%

0.47

22.38%

Dashboard List

415.36%

10.00%

-57.76%

0.57

18.31%

Past performance is not a guarantee of future returns. Data Source: Portfolio123

The Dashboard List slightly outperforms XSVM and shows a lower risk measured in drawdown and volatility. However, the ETF performance is real and the model simulation is hypothetical.

Price to Book: a risky concept of value

I like the idea of mixing various ratios to rank value stocks like XSVM does. However, the underlying index has two shortcomings in my opinion. The first one is to classify all stocks on the same criteria. It means the valuation ratios are considered comparable across sectors. Obviously they are not: you can read my monthly dashboard here for more details about this topic. A consequence is to overweight sectors where valuation ratios are naturally cheaper, especially financials. Sectors with large intangible assets like technology are disadvantaged. Companies with large intangible assets are those with a business model based on massive R&D, or a strong branding, or large user databases, or operating in a field where competition is limited by an expensive entry ticket. All these elements are not correctly reflected by valuation ratios.

The second shortcoming comes from the price/book ratio (P/B), which adds some risk in the strategy. Speaking probabilities, a large group of companies with low P/B contains a higher percentage of value traps than a same-size group with low price/earnings, price/sales or price/free cash flow. Statistically, such a group will also have a higher volatility and deeper drawdowns in price. The next table shows the return and risk metrics of the cheapest quarter of the S&P 500 (i.e.125 stocks) measured in price/book, price/earnings, price/sales and price/free cash flow. The sets are reconstituted annually between 1/1/1999 and 1/1/2022 with elements in equal weight.

Annual Return

Drawdown

Sharpe ratio

Volatility

Cheapest quarter in P/B

9.95%

-72.36%

0.48

21.05%

Cheapest quarter in P/E

11.25%

-65.09%

0.57

18.91%

Cheapest quarter in P/S

12.62%

-65.66%

0.6

20.46%

Cheapest quarter in P/FCF

12.23%

-63.55%

0.61

19.05%

Data calculated with Portfolio123

This also explains my choice of not using P/B in my Dashboard List model (more info at the end of this post).

Takeaway

XSVM follows a rule-based strategy in a small-cap universe using three valuation ratios and a 12-month momentum score. More than one third of asset value is in the financial sector (over 17% in banks). It is on par with its parent index since 2005, with a similar risk measured drawdowns and volatility. It may be a good instrument for a tactical allocation strategy switching between growth and value styles, but it is not convincing as a buy-and-hold investment. Despite a higher expense ratio, XSVM has failed to bring excess return or risk reduction over the small-cap benchmark since 2005. In my opinion, there are two flaws in its strategy: it ranks stocks regardless of their sectors, and using price/book as a primary factor increases the risk of catching value traps. An efficient value model should compare stocks in comparable sets (sector, industry), like I do in the Dashboard List since 2015. This model also uses three valuation metrics, excluding price/book. Moreover, a simple ROE rule helps filter out some value traps and normalize the number of components.

From January 2017 to December 2021, the Dashboard List has returned about 81% (all sectors together) vs. 66% for its benchmark Russell 1000 Value Index (past performance is not a guarantee of future returns). QRV Members get updates on it and other time-tested strategies, plus risk indicators. Get started with a two-week free trial now.

This article was written by

Fred Piard profile picture
14.46K Followers
Data-driven portfolios and risk indicators.
Author of Quantitative Risk & Value and three books, I have been investing in systematic strategies since 2010. I have a PhD in computer science, an MSc in software engineering, an MSc in civil engineering and 30 years of professional experience in various sectors. My aim is making simple and efficient quantitative investing techniques available to my followers. Quantitative models can make investment decisions faster, reproducible and emotionless by focusing on relevant information in the middle of market noise. Moreover, models can be refined to meet specific risk tolerance and objectives. 

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I am an individual investor and an IT professional, not a finance professional. My writings are data analysis and opinions, not investment advice. They may contain inaccurate information, despite all the effort I put in them. Readers are responsible for all consequences of using information included in my work, and are encouraged to do their own research from various sources.

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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