ETF Trends CEO Tom Lydon discussed the VictoryShares USAA MSCI USA Small Cap Value Momentum ETF (USVM) on this week’s “ETF of the Week” podcast with Chuck Jaffe on the MoneyLife Show.

The fund seeks to provide investment results that closely correspond, before fees and expenses, to the MSCI USA Small Cap Select Value Momentum Blend Index performance. The Index is designed to deliver exposure to equity securities of small-capitalization U.S. issuers with higher exposure to value and momentum factors while also maintaining moderate turnover and lower realized volatility than traditional capitalization weighted indexes.

USVM is a great play that ticks all the boxes for the current market environment. The fund helps investors focus on small capitalization stocks that benefit from the early economic recovery stages. It captures the shift toward the value style, notably those that have been enjoying rising momentum.

The Russell 2000 has outperformed the S&P 500 by the widest margin for the first two months of the year since 2000. There’s still a lot of ground that small-caps can make up, given that they’ve lagged for most of the previous bull expansion. Even with the recent outperformance, small caps are still a good ‘value’ play, with a price-to-book ratio well below their large cap peers.

The dominance in the U.S. large cap growth style over the years has contributed to this category’s pricier valuations. Additionally, the U.S. large cap growth was the best style in six of the past seven years, and SPY has been in the top three performers for five of the past seven years as well.

Small capitalization stocks have been outperforming in anticipation of greater fiscal spending from the Biden administration. Given the latest $1.9 trillion relief package and another planned $3 trillion in infrastructure spending, many are growing more optimistic over the broad economic recovery with accelerating vaccination rollouts, accommodative Federal Reserve monetary policy that will keep interest rates near zero for a few more years.

Recovery Phase of the Traditional Economic Cycle

Smaller companies are more sensitive to changes in the domestic economy than their larger peers, which also have a large international footprint. Economically sensitive sectors like energy, materials, and banking also make up a greater portion of the small-cap segment than larger indexes. Once pummeled, cyclical sectors are now attracting bargain hunters betting on a broader recovery.

Value stocks have strong current cash flows that will slow over time, while growth stocks have little or no cash flow today but are expected to increase gradually. When valuing stocks using the discounted cash flow method, in times of rising interest rates, growth stocks are negatively impacted far more than value stocks. Since interest rates are usually increased to combat high inflation, so in times of high inflation, growth stocks will be more negatively impacted. This suggests a positive correlation between inflation and the return on value stocks and a negative one for growth stocks.

Momentum is the rate of acceleration of a security’s price or the speed at which the price is changing. Momentum trading is a strategy that seeks to capitalize on momentum to enter a trend as it is picking up steam. This refers to the inertia of a price trend to continue either rising or falling for a particular, usually taking into account both price and volume information. Based on the idea that “the trend is your friend,” betting on high-flying stocks to fly even higher

In this instance, it is a play on small-cap value stocks and the momentum behind this asset category. Academic research suggests that focusing on stock companies with factors like attractive valuations and improving momentum has led to higher excess returns.

USVM identifies stocks with attractive valuations and positive price momentum and weighting the two factors in such a way to help investors diversify against the risk of individual holdings. If done properly, combining value and momentum can help reduce exposure to value traps–stocks that look cheap but have deteriorating fundamentals. It might also reduce exposure to frothy areas of the market.

Listen to the full podcast episode on the USVM:

For more podcast episodes featuring Tom Lydon, visit our podcasts category.