BPAQF - EFV: Not Much Value In EAFE

Summary

• The relative interest of investors in search of value outside the US has increased in the last few years.
• EFV appears to have attractive multiples, potentially indicating a bargain.
• However, heavy European exposure is a risk given the EU's energy policies and burdensome bureaucracy.
• The historical track record indicates that US value is performing much better, so excluding it doesn’t make sense.

After growth stocks began falling out of favor in the beginning of 2021, a rotation to value began. In terms of geography, it appears that the relative increase in the search of value in EAFE is bigger than in the US as evident from the AUM growth dynamics of the iShares MSCI EAFE Value ETF ( EFV ) compared to the Vanguard Value ETF ( VTV ). In this article I'll examine whether EFV offers a good opportunity or the exclusion of the US may be curbing the potential returns.

While EFV's P/E ratio indicates an earnings yield of around 10%, heavy exposure to Europe may be a problem given the EU's energy policies and too much bureaucracy, making it harder for companies to operate there. At the same time, historical data indicates that the exclusion of the US from a portfolio has led to persistent underperformance.

EFV overview

According to the information provided in its prospectus , EFV is designed to track the performance of the MSCI EAFE Value Index, which in turn is developed to provide exposure to developed markets with the exception of US and Canada. The focus on developed markets implies that emerging economies, which are commodity exporters like the ones in LATAM and the factory of the world - China are also excluded.

When it comes to its holdings, EFV includes 484 securities and has a very attractive P/E ratio of 10.06, implying almost 10% earning yield. The fund is dividend paying, making semi-annual distributions to its shareholders and the current dividend yield is 3.87%.

Looking at the fund's holdings it's evident that exposure to financials dominates. Such heavy financials exposure may be a problem, given the heavy indebtedness of developed economies in a tightening monetary policy environment. At the same time, combined exposure to basic materials and energy of almost 20% is a positive sign as it may benefit from a commodity and energy hungry world.

However, after looking at the top 10 holdings, the energy exposure looks inferior - it includes Shell ( SHEL ), TotalEnergies ( TTE ) and BP ( BP ). All of these European companies have been hit hard by windfall taxes, unlike their US counterparts. Also, there's significant activist push on them to move away from fossil fuels and to increase their exposure to renewables. I think that this puts them in an inferior position to competition from all other geographical regions.

Looking at country and region exposure, it appears that the majority of EFV's holdings are based in Europe. In itself, this could indicate further problems. Besides the disastrous energy policies of the EU and the UK, the bureaucratic burden seems to be affecting companies as well. A very recent example of this is the German concern Bayer ( OTCPK:BAYZF ), which revealed intentions to shift away its pharmaceutical business from Europe citing the unfavorable business environment as the reason.

Benefits of excluding the US?

The idea behind EAFE investing could be diversification and potentially better returns. Looking at the historical returns of EFV compared to a value focused ETF investing exclusively in the US like VTV, it appears that there's significant gap between the two. In a 10-year historical time frame, VTV would've almost tripled an investment, while EFV has yielded only 42% total return.

At the same time, it's hard to argue that EFV has lower risk characteristics (therefore justifying lower return), as the volatility track record of the two ETFs looks close to identical. Not surprisingly, VTV has much better Sharpe ratio than its EAFE peer, indicating superior risk-adjusted performance.

Conclusion

While EFV may look attractive based on its relatively low P/E ratio, the future ahead of it looks challenging. The heavy portfolio weighting towards Europe exposes the fund to the disastrous energy and business unfriendly policies of the EU and the UK. At the same time, the historical track record indicates that value investing in US companies has yielded much better both absolute and risk-adjusted returns to EAFE value investing. Based on that, I see much sense in EAFE value investing through EFV or similar instruments.

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