Smart Beta Channel

Why Value ETFs Could Bounce Back

Exchange traded funds dedicated to the value factor lagged their growth and momentum counterparts in the first half of 2017, but the second half of the year could bring better things for the value factor, particularly if equity market volatility increases.

Investors who believe that value investments may just be the current flavor of the day should keep in mind that value investing is a popular long-term investment strategy. Well-known value ETFs include the iShares S&P 500 Value ETF (NYSEArca:IVE) and the iShares MSCI USA Value Factor ETF (NYSEArca:VLUE).

Momentum came roaring back, after trailing value in the second half of 2016. Based on the USA MSCI Momentum and Value indexes, momentum thrashed value during the first six months of the year, 18% to barely 6%. However, in recent weeks momentum has been stalling, raising the question of whether it can continue to lead the market,” according to a recent note from BlackRock.

The iShares MSCI USA Momentum Factor ETF (NYSEArca: MTUM) is up nearly 19% year-to-date. MTUM tracks large- and mid-cap U.S. stocks with relatively high price momentum. The underlying MSCI USA Momentum Index calculates the ratio of each stock’s price returns over the trailing 13 and seven months against volatility over the past three years. Companies are then weighted by their risk-adjusted momentum.

Boding well for value is that the first half of 2017 set up well for momentum. The environment was almost too perfect for higher beta, momentum stocks.

“Historically, momentum performs best in an environment of low and stable volatility—exactly the regime that has dominated this year,” adds BlackRock. “Although talk of reflation faded, low interest rates, a soft dollar and historically tight spreads kept financial conditions absurdly easy. In June, the Global Financial Stress Index hit its lowest level since late 2014.”

VLUE “seeks to track the performance of an index that measures the performance of U.S. large- and mid-capitalization stocks with value characteristics and relatively lower valuations, before fees and expenses,” according to iShares.

Related: Is it Time to Consider Value ETF Investing Again?

Value stocks usually trade at lower prices relative to fundamental measures of value, like earnings and the book value of assets. On the other hand, growth-oriented stocks tend to run at higher valuations.

The value factor historically performs well over longer holdings, but a current challenge is the dearth of U.S. stocks considered credible value plays. The financial services sector is one of a small number of groups considered legitimate value destinations at the moment.

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