New-to-Market: This featured blog series highlights ETFs that have recently gone public and reflect those strategies currently most in-demand by investors. Our goal is to bring you timely insights on the most cutting-edge investment strategies that have recently embraced the ETF structure and may be too early to be eligible for ETFG Risk & Reward Ratings* – we hope you enjoy this series.
In continuing our “New to Market” series of featured posts, we take a deep dive into the world of value investing strategies. By focusing on the highest yielding securities within a particular benchmark, investors are likely to find those stocks that have lagged the broader index for an extended period with the assumption that mean reversion will lead to relative out-performance in the near future. Filtering the "Alpha Seeking" universe via the ETFG Scanner, we find one deep value fund that not only combines the ease of investing within an ETF and actively managed value investing strategies, but also top-notch performance in its category thus far in 2015 - DVP.
The fund is the new TWM Deep Value Fund ETF (DVP), which was launched late in the 3rd quarter of 2014 and has already gotten off to an impressive start in 2015; up 3.17% YTD putting in the top percentile of its category (Large Value) and well ahead of the .47% gain registered by the S&P 500 from which it draws its components. The fund’s benchmark is the TWM Deep Value Index which draws 20 stocks from the S&P 500 chosen using a simple rules-based methodology that would be familiar to value gurus like Benjamin Graham although not as strict as his “cigar butts” policies.
Companies included in the index must have positive earnings, generate free cash flow and currently pay a dividend. According to the fund’s prospectus, once the list has been derived, the fund will use a weighting system that re-sorts the individual stocks based on different valuation metrics such as FCF, EBITDA and enterprise valuation with the 10 most ‘undervalued’ securities getting 60% of the weighting (7.5% in the first five, 4.5% in the next five) and the bottom 10 getting 4% each. The most undervalued 10 stocks are generally held for a whole year while the other 10 stocks are re-evaluated and reweighted quarterly.
Like the ALPS Sector Dividend Dogs (SDOG), the fund owes a lot of its success in 2015 to the telecommunications sector where the acquisition of land-line customers among other assets from Verizon has pushed Frontier Communications Corp (FTR) up 23.84% YTD and up over 95% in the last year. With over 50 holdings, SDOG’s current allocation to FTR is only 2% whereas DVP has the stock in the top 5 “undervalued” holdings with a current weighting of 8.85% thanks to the strong price appreciation since the last rebalancing with another 7.17% currently in Verizon and slightly less than 4% in AT&T giving the fund heavy exposure to the telecommunications sector where the telecom iShares (IYZ) has underperformed the S&P 500 by 200 bps annually over the last five years. Investors worried about buying into another deep value cigarette-only portfolio, should take heart that consumer discretionary names make up nearly a quarter of the fund where double digit returns from Gamestop and Kohls have added some diversity to the returns generated by the telecom positions.
The ultimate attraction of DVP for many investors may be in part the active management compared to other funds using a deep value methodology like SDOG or the Elements Dogs of the Dow ETN (DOD.) The benchmark used by DVP is reconstituted annually with the top 10 undervalued securities being held for a full year while the ten smaller 4% positions are reconstituted and rebalanced quarterly. Compare that to SDOG, which is reconstituted annually/rebalanced quarterly or DOD, which with only 10 positions has a substantially higher concentration risk and follows the classic Dogs of the Dow theory, so only updates its holdings in December. While DVP does carry a higher expense ratio than SDOG, .8% versus .4% (and is only slightly more expensive than DOD at .75%), the potential value added by periodically “taking some chips off the table” might be more than enough to cover the added expense.
Investors looking for a smarter way to invest along the lines of many classic value strategies but with more liquidity than a mutual fund or separate account might want to keep DVP on their watchlist.
Thank you for reading ETF Global Perspectives!
*Please note that ETFs are eligible for ETFG Red Diamond Risk Ratings following 3 months of trading and ETFG Green Diamond Reward Ratings following 12 months of trading.
This material is not intended as an offer or solicitation for the purchase or sale of any security or other financial instrument. Securities, financial instruments or strategies mentioned herein may not be suitable for all investors. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only correct as of the stated date of their issue. Prices, values, or income from any securities or investments mentioned in this report may fall against the interests of the investor and the investor may get back less than the amount invested. Where an investment is described as being likely to yield income, please note that the amount of income that the investor will receive from such an investment may fluctuate. Where an investment or security is denominated in a different currency to the investor's currency of reference, changes in rates of exchange may have an adverse effect on the value, price or income of or from that investment to the investor.