iShares FOVL ETF: not the best fund to play the value game
Today I would like to discuss the iShares Focused Value Factor ETF (NYSEARCA: FOVL), a concentrated portfolio of financial stocks made up of the cheapest stocks in the Russell 1000.
Although asset flows are robust, FOVL only has around $36 million in net assets. The expense ratio is 25 basis points, slightly below the asset class median. The ETF also returns a healthy 2.7%.
FOVL has a few important advantages, namely broad equity exposure with attractive quantitative valuation ratings coupled with fairly strong quality. But I’m hesitant to give it a Buy rating because of some downsides that shouldn’t be overlooked. The advantages and disadvantages deserve a thorough discussion which is presented below in the article.
FOVL is a relatively new investment vehicle launched on March 19, 2019.
The fund has what I would call a maximalist concentrated value strategy.
According to the prospectus, the fund tracks the equally weighted Focused Value Select Index provided by FTSE Russell, which is meant to encompass high- and mid-range US stocks with “prominent value factor characteristics”.
The Russell 1000 index (monitored by IWB) is its selection universe. To narrow the list to the most undervalued stocks, the index provider first assesses the long-term realized volatility of the constituents of the parent index, removing those in the top 10%. I wouldn’t say I like this rule since less volatile stocks tend to underperform during broad market rallies after steep declines.
In the second step, the total debt/total assets ratio is used to identify companies in over-indebtedness; again, the richest 10% cannot advance to the third stage. I think this rule was certainly added to minimize the risk of value traps spreading through the index, which would pose a substantial threat to its returns; in many cases, excessive leverage combined with a cheap valuation (which usually goes hand in hand with anemic growth) indicates a company’s ongoing destruction of shareholder value, so it’s best to avoid these stocks.
In the third step, consensus earnings estimates from analysts are considered to identify stocks with a poor sentiment score; they are then removed from the pool.
In the fourth step, the weighted composite score amalgamating Price/Book, Price/Dividend, Price/Earnings and Price/Net CFFO is used to select the top 40 stocks “to form a reference or target composition” of the index. The precise weightings of these value factor measures are discussed on page 11 of the methodology. The constituents are weighted equally, which avoids the risk of the benchmark (and the fund’s portfolio) becoming too dependent on a few names with the largest market capitalisations; the review takes place monthly, with rebalancing triggered if certain conditions described on page S-2 of the prospectus are met.
As of March 18, FOVL had a portfolio of 40 stocks, with the top ten representing around 29.5%. My calculations show that the median market capitalization was around $10.7 billion, with a weighted average figure of $21 billion. Overall, it looks like FOVL should appeal to value investors who are skeptical of mega-caps.
Additionally, the fund has a tiny overlap with IWB (its holdings have a ~1.9% weighting in the latter), so it should be a good option for value-oriented opponents trying to reduce their exposure to the market in general, focusing on under-followed and misunderstood stocks. .
I also checked to see if FOVL had any similarities to the Invesco S&P 500 Pure Value Index (RPV), a strong value fund I reported on in January. The analysis revealed that the stocks present in both have a weight of around 36% in FOVL and around 17.7% in RPV.
The value ETF’s sector exposure surprised me a bit. I was expecting to see a fairly large financial presence, but not ~73% of portfolio; its VPN peer is also heavy in banks and others, but with only ~31.7% allocation.
Curiously for a value fund, FOVL has no exposure to materials, industrials and energy, sectors that tend to trade at a discount to the broader market, capital intensity being the factor likely to influence the lower multiples. This is the main reason why I think the ETF is a Hold despite its strong value characteristics described below: its sector exposure is disproportionate, even though most of its financial sector stocks have Hold or Buy ratings As to.
Speaking of exposure to the value factor as measured by the Quant Valuation rating, the fund holds a significant proportion of vastly undervalued stocks, with those rated at least B- having a weighting of almost 59%; this is not ideal but clearly acceptable.
Yet, we see a surprisingly large allocation to growth stocks, around ~27% of those rated B or better; I think this figure would be much lower if the index only used the value factor in the weighting.
To add a little more color, the table below summarizes the quantitative data for the top 25 holdings (~68.5% weight).
There is also an essential question that deserves to be asked. Does cheap FVOL rating correlate with lower quality score? Fortunately, this is not the case, and it seems that detecting excessive leverage and negative sentiment has also helped to identify and eliminate companies with low margins and low market returns. capital. In inspecting the FOVL portfolio, I discovered that approximately 80% of the holdings had no less than a B- profitability rating. It’s a solid result, but in all honesty, it was also partly a consequence of his focus on large caps. In a small/mid cap portfolio, this figure would be much lower.
To provide even more color, below is the scatter plot illustrating the NI margins and return on equity of FOVL holdings. I opted for these parameters because the EBITDA margin and the ROTC which I use frequently do not make sense for the financial sector.
We only see two loss-making companies, namely Vistra (VST) and Xerox (XRX), with the others having decent margins and ROE; this once again reinforces the fact that the quality of the portfolio is high.
Does a concentrated maximalist value portfolio beat the market?
For now, the answer is no. Not yet. We only have three full trade years to analyze, with most of the period of the coronavirus stock market era marked by excessive government stimuli. So I would say that the results are mainly distorted by the ultra-loose monetary policy, and during the hawkish period the fund could perform quite differently, especially given its strong position in financials.
The table below compiles the returns of FOVL and a few selected peers, namely Invesco S&P 500 Enhanced Value ETF (SPVU), iShares Russell 1000 Value ETF (IWD) and RPV. IWB is supposed to represent the entire market. The period covered is April 2019 – February 2022.
As seen, the CAGR of FOVL is the lowest, only ~10.2%. Sharpe and Sortino ratios are also poor, indicating lower reward for higher risk.
The silver lining I see here is its best year ever (2021) when, thanks to stock rotation, cheaper stocks were back in fashion.
This year, FOVL has performed well, with price performance being the second strongest of the selected cohort.
This momentum is likely to continue into 2022, supported by interest rate hikes in the United States
The verdict? I’m skeptical of FOVL, even though its portfolio performs well against quantitative valuation metrics. The main reason is that its sector composition is disproportionate. I would like to see industrial and materials stocks in the mix. I should mention that a small AUM of only ~$36M and low volume also comes with risks. Overall, FOVL is a catch.