Good Morning, VettaFi Voices! Growth has blown value out of the water in 2023. It’s not even close. The Vanguard Value ETF (VTV) is up less than 1% year to date. Meanwhile, the Vanguard Growth ETF (VUG), the growth fund, is up 32%. That’s a big difference, and clearly we’re in a growth regime. Gaps like that between value and growth performance aren’t too unusual. Should investors be preparing for a regime change toward value?
Jane Edmondson, VettaFi Head of Thematic Strategy: I think there are a lot of nuances to value’s prolonged underperformance as an asset class. For one thing, there is the question of how you measure value, because a lot of standard measures of valuation are not applicable in the modern context. And then there is the issue of company productivity and efficiency. Disruptive technologies like AI, automation, and blockchain increase productivity and help keep prices down in an inflationary environment. That favors growth companies over the long term.
A “Barbelled” Market
Dave Nadig, VettaFi Financial Futurist: We’re currently in a deeply barbelled market. We have record high amounts of cash still in short duration and money markets, and the flows into equities have largely chased the hot sauce. But I think it’s worth noting that an enormous amount of money has flowed into equity-income and buffered-type products. It’s reasonable to suggest that these are “the new value” for a lot of advisors and investors. After all, the point of value in a full portfolio has often been to lower volatility and protect yourself when the market shifts away from “go go go” tech growth.
I have actually heard several advisors refer to funds like the JPMorgan Equity Premium Income (JEPI) as their “value allocation” even though that’s very clearly not how the fund is constructed. I suspect the phase shift we’re seeing is less a traditional rotation into low P/B stocks and a redefinition of what safety means in a portfolio context.
All that said, I’d point to the Avantis U.S. Small Cap Value fund (AVUV) as one of the more useful knives in the toolbox for investors looking for value. It’s cheap (25 bps) and has been beating its index comps just by doing what they always do: focusing on risk management, low turnover, and smart execution, rather than shoot-the-lights-out active share.
Rosenbluth: Growth or value is in the eye of the index provider if the ETF tracks an index. I’ll try to respond to Dave’s active ETFs soon and may forget. But VTV and VUG track CRSP indexes. The SPDR Portfolio S&P 500 Growth ETF (SPYG) and the SPDR Portfolio S&P 500 Value ETF (SPYV) track S&P indexes, and the iShares Russell 1000 Growth ETF (IWF) and iShares Russell 1000 Value ETF (IWD) track Russell ones.
Differences Among Growth & Value Indexes
The gap between IWF and IWD is narrower than the gap between the Vanguard funds at 2,600 basis points. The gap between SPYG and SPYV is only 1,200 points. All of those are absurdly wide, but what’s inside the ETFs are not the same. SPYG holds Exxon Mobil and Chevron for example, but not META, unlike peers. The index criteria is different at each firm.
Active managers have greater discretion to determine what stocks are undervalued and to make changes through the year, not just on index rebalancing days. Is Netflix, which is up sharply on earnings news as I type this, still worth holding? How about Tesla, which is down? That’s up to the manager of an active ETF like the T. Rowe Price Blue Chip Growth ETF (TCHP).
Growth ETFs tend to have more info tech and consumer discretionary stocks inside, and value tends to have more financials. But there’s exposure to most of the sectors in both.
Nadig: Well, let’s not forget the “purity” issue here. The Invesco S&P 500 Pure Growth ETF (RPG) and the Invesco S&P 500 Pure Value ETF (RPV) pair is pretty unique in that it slices out the “sort of both” stocks and each fund only invests in the “growthiest” or “valuey-est” stocks in the S&P 500. I actually think the reality of modern markets is that if you were to start your factor system after the global financial crisis, you wouldn’t find the distinctions so clear. A lot of style-box investing is based on how stocks performed in a different era — literally a different world.
Do Your Homework
Rosenbluth: Good point on style-purity ETFs like RPG and RPV. Those are cleaner, more targeted ways to get growth or value, but wow, there’s a notable performance difference between them and their more diversified peers. RPG is up just 2.9% this year, lagging VUG by a lot. RPG has 30% in energy and just 15% in infotech. Diamondback Energy and Targa Resources are top positions. This is far from Apple and Microsoft.
This is a perfect example of don’t buy a growth ETF or a value ETF just because. Do your homework!
Heather Bell, VettaFi Managing Editor: Does the value premium still exist?
Edmondson: Different value products measure valuation differently. I think the value premium still exists. It still makes intuitive investment sense to buy low and sell high. The ambiguity lies in how best to capture pricing inefficiencies in a technological world full of intangibles such as data and intellectual property.
Rosenbluth: Factor ETF fans will certainly say yes. There’s a value factor ETF, the iShares MSCI USA Value Factor ETF (VLUE), that is sector-constrained, looking for the best value in each sector. This does not exist for growth. Value, with momentum, quality and size, are the most commonly accepted factors where premiums exist.
Edmondson: That raises the question: Is growth captured by momentum? Is it already priced in? And lately, if you look at the index composition of the S&P 500 for example, you can also see a huge mega-cap size tilt with the outperformance of big tech names.
As the valuations of these names creep up, how much is too much to pay for a growth name like Nvidia?
When Momentum Looks Like Value
Rosenbluth: Momentum is not growth. Momentum is whatever is working recently. So when energy stocks rallied and tech fell, momentum ETFs look much more like a value ETF. The iShares MSCI USA Momentum Factor ETF (MTUM), the First Trust Dorsey Wright Focus 5 ETF (FV) and the Invesco Dorsey Wright Momentum ETF (PDP) are momentum ETF examples.
Edmondson: Good point! Energy is definitely a sector seeing some momentum right now, although it is traditionally a value and dividend play.
Rosenbluth: To the earlier question about what’s ahead, I’m less qualified to forecast. But if the Fed is indeed done hiking rates and bond yields narrow, then dividend-paying value stocks are more likely to look appealing. The dividend-paying sector ETFs like the Utilities Select Sector SPDR Fund (XLU) and the Consumer Staples Select Sector SPDR Fund (XLP) are down this year. If stable dividends matter more, then value will be more competitive with growth
Edmondson: That applies to steady cash flows as well in support of those dividends. There are some great ETFs capturing free cash flow yield such as the Pacer US Cash Cows 100 ETF (COWZ) and others.
Rosenbluth: Good point! I recently wrote about how COWZ has more value exposure than the newer entrant to the market, the VictoryShares Free Cash Flow ETF (VFLO), which has a growth filter.
Productivity Gains From Innovation
Zeno Mercer, VettaFi Senior Research Analyst: Great points by everyone so far. Yes, the world is marked and measured greatly by different eras of productivity gains. Henry Ford integrated process and automation into the manufacturing line, long before robots were involved. McDonald’s systematized fast food. Walmart figured out how to integrate millions of SKUs and economies of scale that were unheard of and completely ate Sears’ breakfast, lunch, and dinner.
We’ll continue to see new modalities and importance of automation, especially as AI and robotics continue to improve their value proposition in the face of labor shortages in key areas such as U.S. manufacturing and healthcare (while improving safety and quality of life).
I believe I saw somewhere that the delta/spread in valuation between large/mega and SMID is the largest in quite some time. I like more, generally, the method of targeting value or growth by niche sectors. Many of the mentioned funds are also U.S.-only based indexex baskets that span all industries essentially. Over the past decade, growth has certainly far outpaced value by all metrics, including higher performance and beta (in both directions). I think what’s most striking is how different the index construction and methodologies are and the options available to investors.
People are realizing that excess inflation with record gross margins likely means that we’re getting squeezed. Overall, the state of the economy feels a bit “stretched thin.” I see value as playing into longer-term trends and areas that have bookmarked government spending, increasingly enterprise spending and adoption rates ticking up. Sometimes “value” is value for a reason — and in a potentially harsh environment doesn’t necessarily normalize. Maybe some are looking for a hedge of some sort, but there are vehicles better suited for that.
Headwinds for Financials and Healthcare
Overall, it’s been a tough year for financial and healthcare sectors, for instance. Mega-tech is creeping into more facets of life and business activities, and thus has seen market share gains as an overall percentage of GDP. They are facing, however, increasing pressure from the U.S., EU, and China regulators on anti-trust, fairness, and even algorithmic neutrality (especially in EU). That could dampen some of their main business lines and put some valuation pressure on them (and potentially lower some expectations, as we’ve seen with Tesla just now with its Q3 earnings).
Rosenbluth: Value is value for a reason. I like saying “don’t catch a falling knife.” But maybe that’s because that scares me more.
Edmondson: What about the new hybrid trend to hedge growth stocks with option income? The YieldMax ETFs are seeing lots of flows as an income play on growth stock volatility with the YieldMax TSLA Option Income Strategy ETF (TSLY) and the YieldMax NVDA Option Income Strategy ETF (NVDY) hedging the performance of Tesla and NVIDIA.
There is even one on Coinbase (COIN) for crypto lovers: the YieldMax COIN Option Income Strategy ETF (CONY).
Tech and Natural Resources Dividends
Rosenbluth: Finding income even though the companies don’t pay a dividend to give it a slightly more value feel? Interesting. That’s the alternative to the First Trust NASDAQ Technology Dividend Index Fund (TDIV) and the Amplify Natural Resources Dividend Income ETF (NDIV) that focus on the dividend-paying companies in sectors that don’t always pay them.
Edmondson: TDIV, the growth play on that angle, is focused on technology dividends, while NDIV is the natural resource dividend play, a dividend-weighted, more concentrated version of the FlexShares Morningstar Global Upstream Natural Resources Index Fund (GUNR) and the SPDR S&P Global Natural Resources ETF (GNR).
I am beginning to think the growth versus value debate is like an onion!
Rosenbluth: Can it be something more enjoyable than an onion? Unless you’re catching the falling knife. How about a pumpkin, since it’s almost Halloween? I like the seeds and the filling in a pie.
Edmondson: OK, let’s peel back the layers of a pumpkin in honor of Halloween!
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