- Value stocks and funds have outperformed all year.
- AVUV is one of the best-performing value ETFs of the year, and since inception.
- An overview of the fund follows.
- This idea was discussed in more depth with members of my private investing community, CEF/ETF Income Laboratory. Learn More »
Author's note: This article was released to CEF/ETF Income Laboratory members on August 12th, 2022.
Value has outperformed all year, as skyrocketing inflation, worsening economic conditions, and rising interest rates have brought frothy growth valuations back to earth. Value funds have seen their strongest relative performance in years, with the Avantis U.S. Small Cap Value Fund (NYSEARCA:AVUV) achieving particularly outstanding results. AVUV has outperformed relative to most, if not all, major value funds and U.S. equity indexes for the past year, and since inception too. AVUV's performance is mostly due to consistent generation of alpha: the fund picks the right industries and stocks, at the right time. AVUV is also reasonably well-diversified and, obviously, sports a cheap valuation.
AVUV's diversified holdings, cheap valuation, and strong performance track-record, make the fund a buy. AVUV only yields 1.5%, and so is not an effective income vehicle.
AVUV - Holdings Analysis
AVUV is an actively-managed U.S. small-cap value ETF. Some actively-managed funds are quite concentrated and lack diversification, but that is most definitely not the case for AVUV. The fund's investment management team aims to construct a portfolio with index-like diversification, and they have (mostly) succeeded. AVUV's holdings are incredibly well-diversified, with investments in hundreds of securities, and exposure to all relevant industry segments. Concentration is quite low too, with the fund's top ten holdings accounting for under 10% of its value.
As with most other value funds, AVUV is currently overweight cheap, old-economy industries like financials and industrials, while being underweight frothy, expensive tech.
AVUV is an incredibly well-diversified fund, more or less as diversified as the average U.S. equity index, including the S&P 500 (which has fewer holdings). Diversification reduces portfolio risk, volatility, and the possibility of substantial losses or underperformance due to an underperforming holding, all significant benefits for the fund and its shareholders.
AVUV is a small-cap equity fund, and so the fund's holdings are, well, relatively small. As an example, Triton International (TRTN), the fund's largest holding, has a market-cap of $4.0B. Most well-known U.S. equities, as well as most of the holdings of most well-known U.S. equity indexes, have market-caps in the hundreds of billions.
AVUV's holdings are significantly smaller than average, as one would expect from a small-cap fund. They are also smaller than the average small-cap equity index fund, so it seems that the fund's managers are really targeting smaller, less well-known issuers.
As AVUV does not invest in large-caps, the fund's holdings materially differ from those of most U.S. equity indexes. Indexes like the S&P 500 or Nasdaq-100 invest quite heavily in Apple (AAPL), Microsoft (MSFT), JPMorgan Chase (JPM), Johnson & Johnson (JNJ), and similar companies. AVUV does not invest in these and other large-cap U.S. equities, only in smaller companies. As AVUV's holdings materially differ from those of most U.S. equity indexes, the fund's performance could materially differ from that of said indexes as well. There is quite a bit of risk here, as AVUV could easily post significant losses even as U.S. equity markets post gains, as the fund simply does not invest in most of the holdings which comprise said markets.
U.S. equity markets are, in a sense, mostly comprised of large companies, like Apple and Microsoft. As AVUV does not invest in these and other large-cap U.S. equities, and so does not provide investors with diversified exposure to the U.S. equity investable universe or market.
In my opinion, although AVUV is quite diversified, the lack of exposure to large-cap U.S. equities make it an inappropriate core portfolio holding. AVUV could supplement an investor's equity portfolio or holdings, but these should mostly be comprised of funds with greater large-cap equity exposure.
AVUV - Cheap Valuation
AVUV is a small-cap value ETF, investing in industries companies trading with relatively cheap prices and valuations. As the fund is actively-managed, security selection and weights are ultimately a management decision, subject to management discretion. From what I've seen, the fund focuses on companies with relatively cheap book to price ratios, usually referred to as price to book, and low earnings to book ratios. The latter is a relatively uncommon valuation metric, but a perfectly valid one too. AVUV does score relatively well in these two metrics, as expected.
The fund also scores relatively well on PE and PB ratios, two more traditional valuation metrics.
Stocks with low share prices and cheap valuations can experience significant capital gains and market-beating returns, contingent on valuations normalizing. Conditions are such that this is a distinct possibility, in my opinion at least. Some context first.
Value stocks have, by definition, lower share prices and cheaper valuations than average. Although this is always the case, value stocks are looking particularly cheap right now. As per JPMorgan, value stocks are currently around 10% cheaper than their historical average. Growth stocks are marginally more expensive than average, while the stock market as a whole is very slightly cheaper than average. The valuation gap between value and growth is currently elevated, although it was wider earlier in the year, and during the dot-com bubble.
Significant, unprecedented valuation gaps rarely persist for long, and when they narrow, value stocks outperform. Importantly, and as can be seen above, valuation gaps have already started to narrow. Value stocks were cheaper, and growth stocks were more expensive, earlier in the year. Valuations have started to normalize since, during which AVUV, and most other value funds, have outperformed, as expected.
AVUV's cheap valuation could lead to significant capital gains if valuations were to normalize, as has been the case YTD, an important benefit for the fund and its shareholders.
AVUV - Outstanding Performance Track-Record
AVUV's diversified holdings and cheap valuation are important, but common, benefits. There are simply many diversified value index ETFs out there, including several targeting specific market niches. The Vanguard Small-Cap Value ETF (VBR), for instance, invests in U.S. small-cap value stocks, same as AVUV.
AVUV's most important differentiator, what sets the fund apart from its peers, is its outstanding performance track-record. AVUV outperforms small-cap value indexes during bull markets, and when economic and industry conditions are favorable. AVUV tends to match the performance of these same indexes during bear markets, and when conditions are not so favorable. There is an asymmetry here, with the fund sometimes outperforming, but rarely underperforming, relative to its peers. The end result is a fund which consistently outperforms relative to small-cap value indexes, and which generally outperforms relative to broader equity indexes.
Importantly, AVUV has moderately outperformed relative to the S&P 500 since inception, even as small-caps, value, and small-cap value stocks have all underperformed the same. AVUV has managed to outperform the S&P 500 during broadly unfavorable market conditions, a significant benefit for the fund and its shareholders.
AVUV's outperformance is due to consistent generation of alpha by the fund's investment management team. AVUV tends to pick the right industries, and the right stocks, at the right time. As an example, the fund increased its energy exposure earlier in the year, just before energy stocks soared due to increased energy prices and improving investor sentiment.
Conclusion - Buy
AVUV's diversified holdings, cheap valuation, and strong performance track-record, make the fund a buy.
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This article was written by
Juan de la Hoz has worked as a fixed income trader, financial analyst, operations analyst, and as an economics professor. He has experience analyzing, trading, and negotiating fixed-income securities, including bonds, money markets, and interbank trade financing, across markets and currencies. He focuses on dividend, bond, and income funds, with a strong focus on ETFs.
Juan is a contributor to the investing group CEF/ETF Income Laboratory which is led by Stanford Chemist. Features of the service include: managed income portfolios (targeting safe and reliable ~8% yields) making use of high-yield opportunities in the CEF and ETF fund space. These are geared toward both active and passive investors of all experience levels. The vast majority of CEF/ETF Income Laboratory holdings are also monthly-payers, for faster compounding and steady income streams. Other features include 24/7 chat, and trade alerts. Learn More.
Analyst’s 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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