The value factor as it is applied to small-cap stocks has proven potent over long holding periods, but investors should not be forced to pay up for that advantage. The Vanguard Small-Cap Value ETF (NYSEArca: VBR) ensures that is not an issue.
VBR charge just 0.08% per year, the equivalent of $8 on a $10,000 investment. That makes VBR one of the least expensive small-cap value funds on the market today.
The outperformance may be attributed to the small-cap, value-oriented ETFs’ tilt toward favorable sectors in the current market environment. Specifically, financials and industry, two outperforming sectors in recent weeks, make up a large portion of the funds’ underlying holdings.
In the case of VBR, the Vanguard ETF allocates over half its weight to financial services and industrial stocks. Financial stocks are often one of the largest sector allocations in value ETFs, regardless of what market capitalization the fund emphasizes.
VBR’s “approach promotes low turnover, effectively diversifies risk, and accurately represents the opportunity set available to active managers. The resulting portfolio includes just over 800 holdings such as JetBlue, Rite Aid, and Barnes & Noble. Most of these firms do not enjoy sustainable competitive advantages,” said Morningstar in a recent note. “They also tend to have poor growth prospects and, in many cases, limited profitability, so they are not necessarily bargains. But they could become undervalued if investors extrapolate lackluster past growth too far into the future.”
VBR’s large financial services weight could prove advantageous moving forward. Dodd-Frank has forced many banks to increase more conservative capital holdings to obviate another potential financial crisis event. While these more secure capital restrictions help limit exposure to risky or distressed assets, banks are finding it harder to make loans and do business. The regulations have also been particularly hard on smaller banks.
Meanwhile, a rising interest rate environment helps banks’ bottom line. With the Federal Reserve enacting a recent interest rate hike and looking to add three more next year, banks are able to make a larger profit off the spread between loans and deposits.
Over the long-term, volatility from small-cap value stocks compares favorably with traditional small-cap indexes.
“Small-cap stocks have indeed historically compensated investors for their risks over the long term. From its inception in December 1978 through March 2017, the Russell 2000 Value Index (which offers similar exposure to this fund) outpaced the Russell 2000 Growth Index by about 3.5 percentage points per year,” adds Morningstar.
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