DFSV - SLYV In 2023: Strengths And Weaknesses Of A Value ETF

2023-04-03 07:51:29 ET

Summary

• SPDR S&P 600 Small Cap Value ETF uses 6 metrics to pick stocks.
• It is well-diversified.
• It is close to its parent index in sector breakdown, valuation, total return, and volatility.
• Most value indexes have two weaknesses.

SLYV strategy and portfolio

The SPDR S&P 600 Small Cap Value ETF ( SLYV ) has been tracking the S&P SmallCap 600 Value Index since 9/25/2000. It has a portfolio of 457 stocks, an expense ratio of 0.15% and a 12-month distribution yield of 1.76%.

As per the S&P Dow Jones Indices prospectus, the S&P 600 constituents are categorized based on their value and growth potential, evaluated using three valuation ratios and three growth metrics. The valuation ratios are book value to price, earnings to price and sales to price. By definition, 33% of S&P 600 constituents exclusively belongs to each style, and 34% belongs to both styles. The Value style subset is considered the S&P 600 Value Index, rebalanced yearly, capital-weighted, with an adjustment for constituents belonging to both styles. For instance, a company with a higher value rank than its growth rank is given a higher weight in the Value Index than in the Growth Index.

SLYV invests almost exclusively in U.S. companies (99.6% of asset value). It is cheaper than its parent index, represented hereafter by iShares Core S&P Small-Cap ETF ( IJR ), regarding usual valuation ratios (reported in the next table). Though, the difference is smaller than expected from a value fund.

The three heaviest sectors are the same in SLYV and IJR, but in reverse order: consumer discretionary, financials and industrials (see next chart). Together, they weigh 53% of SLYV asset value. The portfolio is well-diversified sector-wise: none weighs more than 20%. Compared to the S&P 600, SLYV significantly overweighs consumer discretionary and real estate, and it underweights technology. Except for these 3 sectors, the value ETF is quite close to its parent index regarding the sector breakdown. It may partly explain why valuation ratios are similar.

The top 10 holdings, listed below with valuation ratios, represent 7.8% of asset value, and the heaviest position weights about 1%. Therefore, we can consider the fund is also well-diversified across holdings. Risks related to individual companies are very low.

Performance

Since October 2000, the difference between SLYV and IJR in return and risk metrics is not significant: only 5 bps in annualized return, about 3 percentage points in maximum drawdown and 65 bps in volatility (standard deviation of monthly returns). Their risk-adjusted performances are identical (Sharpe ratio in the table below).

The next chart compares SLYV total return in the last 12 months to 4 competitors:

• Vanguard Small-Cap Value Index Fund ( VBR ), reviewed here
• iShares Russell 2000 Value ETF ( IWN ), reviewed here
• Avantis U.S. Small Cap Value ETF ( AVUV ), reviewed here
• Dimensional US Small Cap Value ETF ( DFSV )

SLYV is in the middle of the pack, which is dominated by the actively managed fund by Dimensional. A note of caution though: this period is too short to make a claim about DFSV performance on the long term.

Comparing SLYV with my value benchmark

The Dashboard List is a list of 80 stocks in the S&P 1500 index, updated every month based on a simple quantitative methodology. All stocks in the Dashboard List are cheaper than their respective industry median in Price/Earnings, Price/Sales and Price/Free Cash Flow. After this filter, the 10 companies with the highest Return on Equity in every sector are kept in the list. Some sectors are grouped together: energy with materials, communication with technology. Real estate is excluded because these valuation metrics don't work well in this sector. I have been updating the Dashboard List every month on Seeking Alpha since December 2015, first in free-access articles, then in Quantitative Risk & Value.

The next table compares SLYV performance since inception with the Dashboard List model, with a tweak: here the list is reconstituted once a year to make it comparable with a passive index.

Past performance is not a guarantee of future returns. Data Source: Portfolio123

The Dashboard List beats SLYV by 3.4 percentage points in annualized return and shows a lower risk in drawdown and volatility. Another note of caution: ETF performance is real and the list is simulated.

Some fundamental shortcomings

Most value ETFs have two shortcomings in my opinion, and SLYV is no exception. The first one is to classify all stocks on the same criteria. It means the valuation ratios are considered comparable across sectors. Obviously they are not: my monthly dashboard here shows how 3 median valuation ratios may differ across sectors now and in historical averages. A consequence is to overweight sectors where valuation ratios are naturally cheaper, especially financials. Some other sectors are disadvantaged: those with large intangible assets like technology. Companies with large intangible assets are those with a business model based on massive R&D, or a strong branding, or large user databases, or operating in a field where competition is limited by an expensive entry ticket. All these elements are not correctly reflected by valuation ratios. It might explain why actively managed value funds have outperformed index value funds recently.

I like the idea of combining the size factor with various value metrics like SLYV does. Among them, the price/book ratio (P/B) is the historical value factor from the Fama-French three-factor model. However, statistics in the last two decades show that it may add some risk in the strategy. Historical data show that a large group of companies with low P/B has a higher probability to hold value traps than a same-size group with low price/earnings, price/sales or price/free cash flow. Statistically, such a group will also have a higher volatility and deeper drawdowns in price. The next table shows the return and risk metrics of the cheapest 25% of the S&P 500 (i.e.125 stocks) measured in price/book, price/earnings, price/sales and price/free cash flow. The sets are reconstituted annually between 1/1/2000 and 1/1/2023 with elements in equal weight.

Data calculated with Portfolio123

This explains why I use P/FCF and not P/B in the Dashboard List model.

Takeaway

SPDR S&P 600 Small Cap Value ETF follows a quantitative value strategy using 3 valuation metrics and 3 growth metrics. The portfolio is well-diversified across sectors and holdings. No sector weighs more than 20% of asset value and no stock weighs more than 1%. The sector breakdown is close to the parent index S&P 600. Valuation ratios, past performance and risk metrics are also similar to the S&P 600. SLYV may be useful in a tactical allocation strategy (growth/value or small/large rotation for instance), but it has not shown significant excess return or risk reduction over the small cap benchmark since 2000. It is a good all-purpose small-cap fund, but it has two methodological weaknesses in my opinion: ranking stocks regardless of their industries, and relying too much on the price/book ratio.

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