By Todd Rosenbluth, CFRA
“An ongoing shift to passive investing through ETFs” – this is a phrase that gets used so frequently that it is not surprising that many investors have ceased paying attention to it. One might even be left with the false impression at all ETFs are passive. Buyer beware!
Over the past five years, assets in ETFs nearly tripled and ETF providers are increasingly launching non-indexed ETFs or indexed ETFs with a twist that makes their underlying holdings less static many investors may initially think without further investigation.
In our discussion with asset management industry experts for CFRA’s ETF video series, https://newpublic.cfraresearch.com/etf-videos/ , we covered a range of ETF-related topics. One common theme was ensuring advisors and investors understand what’s inside the growing number of ETFs.
Doug Grim, senior investment strategist at Vanguard Group, explained to CFRA in a recent video that investors have been rotating out of active mutual funds in search of lower-cost investments. Grim thinks in general lower-cost products will continue to gather assets; watch his video here: https://newpublic.cfraresearch.com/move_to_smart_beta/
CFRA thinks advisors and investors correctly focus on expense ratios when selecting both mutual funds and ETFs. Our ratings incorporate this key cost metric. However, we agree with Grim that with ETFs it is particularly important to look under the hood as he correctly points out that these index-based products can be constructed in a variety of different ways.
With value ETFs for example, there are products constructed based on a combination of style and market capitalization. Meanwhile, other products are constructed based on their value factor score. The exposure these funds provide is distinct.
Vanguard offers multiple products that, at first blush, sound like they would hold similar stocks. For example, Vanguard S&P 500 Value ETF (VOOV 109 Overweight) includes book-to-price, earnings-to-price and sales-to-price criteria to sorting the S&P 500, while Vanguard Value ETF (VTV 108 Overweight) also uses those three and adds in forward earnings-to-price and dividend-to-price metrics.
Microsoft (MSFT 108 ***) is the largest holding in VTV but is not a constituent in VOOV as the stock is considered growth, based on the S&P 500 Style indices.
While CFRA does not use a three-year record in its ETF rating, VTV’s 11.1% annualized total return as of July 24 significantly outperformed VOOV’s 9.2%. To us, this performance variance highlights the importance of understanding what makes them different.
Meanwhile, iShares Edge MSCI USA Value ETF (VLUE 85 Overweight) is an example of one of the smart beta ETFs weighted based on their value factor scores using historical earnings, revenue, book value and cash earnings metrics. However, VLUE is built with sector neutrality and as such, its 25% weighting in technology is considerably higher than VTV (15%) and VOOV (7%), which do not incorporate sector weightings.
The index behind VLUE is rebalanced on a semi-annual basis, VTV is quarterly, and VOOV is annually.
In February, Vanguard launched a new suite of factor ETFs including Vanguard US Value Factor (VFVA 80 Overweight), which uses book-to-price, forward earnings-to-price and cash flow-to-price metrics to rank large-, mid- and small-cap stocks.
However, unlike index-based ETFs VLUE, VTV and VOOV, VFVA is actively managed. Vanguard’s quantitative portfolio managers have discretion to buy and sell stocks at any time, rather than waiting for the next index rebalance. CFRA thinks this will prove more meaningful as the $35 million ETF gathers further inflows.
In late July, VFVA had a 26% weighing in financials, up from 25% at the end of June. The fund’s overall median market capitalization of $2.4 billion is well below the $15 billion for VLUE and Vanguard’s other index-based value ETFs.
Another firm offering actively managed equity ETFs is Davis Advisors. Dodd Kittsley, director at Davis Advisors, explained to CFRA that Davis continually educated investors that its ETFs do not track an index. Using the ETF wrapper, investors still get the transparency and trading and tax efficiency for active management. The firm launched its fourth ETF, Davis Select International (DINT) in March 2018.
Watch the video on our website: https://newpublic.cfraresearch.com/actively_managed_etfs/.
Oppenheimer, another ETF provider, supplies additional examples. Multi-factor ETFs launched in November 2017 from Oppenheimer are index-based but the factor exposure can shift dynamically on a monthly basis.
Mo Haghbin, head of product Beta Solutions at Oppenheimer Funds, explained to CFRA that these products rotate through the factors based on the leading market indicators and investor sentiment. Watch the video at our website: https://newpublic.cfraresearch.com/dynamic_mulitfactor_etfs/.
When we spoke to Haghbin in June, Oppenheimer Russell 1000 Dynamic Multifactor ETF (OMFL 28 Marketweight) was overweighted to quality and low volatility based on the decreasing global risk appetite. The fund remained positioned that way in late July, but this is not a static allocation. Throughout the first quarter of 2018, OMFL was positioned for expansion and favored size, value and momentum factors.
While the ETF’s technology weighting of 29% is relatively high versus the Russell 1000 index, top positions include MasterCard (MA 210 ***) and Texas Instruments (TXN 114 ***), which have above-average S&P Global Market Intelligence Quality Rankings.
Oppenheimer also launched single factor ETFs in late 2017, including Oppenheimer Russell 1000 Value Factor (OVLU 27 Overweight). This ETF tracks a traditional index of large-cap stocks weighted and selected using cash flow yield, sales-to-price and earnings yield.
In rating these and other ETFs, CFRA combines holdings-level analysis with fund attributes including expense ratio. Reports can be found on MarketScope Advisor.
Todd Rosenbluth is Director of ETF & Mutual Fund Research at CFRA.