We believe that Value will make a comeback at some point, and that it will give us a “tailwind” versus a pure Index portfolio over the long term.
So once an investor decides to add Value to their portfolio, what is the next step?
The ETF market offers many choices when it comes to Value exposure: there are a myriad of offerings available. At Hillswick, we like to start with Sector ETFs to minimize tracking error to the S&P 500 Index, which is our benchmark. There are 11 high-level sectors, called GICS sectors, in the S&P 500 Index. They are:
- Communication Services
- Consumer Discretionary
- Consumer Staples
- Health Care
- Information Technology
- Real Estate
A basic Sector ETF will contain every issue in the underlying sector weighted according to the Index, so for example, if one were to buy XLF, they would own a basket of stocks consisting of every issue in the S&P 500 Financials Sector weighted according to the index. That means by definition that the ETF itself will have no factor exposures to the Financials Sector.
The sector will however have factor exposures to the S&P 500 Index as it only represents a portion (roughly 13% as of 12/31/2018) of the entire index.
This is where it gets interesting for someone wanting a diversified portfolio with exposure to the S&P 500 Index in a broad sense but also wants the added tailwind of Value.
What if we could own most of the S&P 500 Index through low-fee Index ETFs and get Value exposure at the same time?
We think this can be achieved by adding more exposure to sectors that score high on Value (low Price/Earnings and Price/Book ratios). A simple process would be to rank sectors on the Value scale and then weigh them according to how attractive they are. So for example right now a portfolio at the start of 2019 with a Value tilt would be overweight Financials, Materials and Energy based on low P/Es and P/B while being underweight Consumer Discretionary, Consumer Staples and Information Technology. To gain even more Value exposure one could look at sub-sectors such as Telecommunication Services, which is now a subsectwor of Communication Services, and Automobiles and Components, a subsector of Consumer Discretionary. It is sometimes easier to add additional exposure to these “cheap” sub sectors by owning individual shares to complement your overall ETF portfolio, as narrow sub sectors may not be available as ETFs.
The portfolio described above would give an investor more exposure to Value relative to the index but would also expose the portfolio to other risks, such interest rate risk (what happens if rates go up?), making it important to consider overall exposure when one strays from the index (in this case the S&P 500).
We believe combining a Value-driven approach with a top-down Macro outlook provides the best risk-adjusted returns over the long term.
*Views expressed above are solely the opinions of the investment professionals at Hillswick Asset Management, LLC (HAMLLC) and are subject to change at any time without notice. Market data presented is provided by third party and HAMLLC is not responsible for any errors or omissions in the data (sourced from Bloomberg as of 01/08/2019). HAMLLC as a Registered Investment Advisor invests in many of the security types, sector and/or industries discussed above. This information piece is not intended as investment advice or a recommendation to buy or sell any security or security type.