FVAL - VOOV: A Good Value ETF Despite Methodological Shortcomings

2023-07-10 14:45:14 ET

Summary

• Vanguard S&P 500 Value ETF selects large-cap stocks based on book value-to-price, earnings-to-price, and sales-to-price ratios.
• It is better diversified across sectors than the S&P 500.
• It has lagged the benchmark since inception, but performs well among peers.
• I see two shortcomings in the underlying index.

This article series aims at evaluating ETFs (exchange-traded funds) regarding past performance and portfolio metrics. Reviews with updated data are posted when necessary.

VOOV strategy and portfolio

Vanguard S&P 500 Value ETF ( VOOV ) started investing operations on 09/07/2010 and tracks the S&P 500 Value Index. It has 405 holdings, a 12-month distribution yield of 1.95% and a cheap expense ratio of 0.10%. Dividends are paid quarterly. It is a direct competitor to iShares S&P 500 Value ETF ( IVE ) and SPDR Portfolio S&P 500 Value ETF ( SPYV ), two funds tracking the same underlying index.

As described by S&P Global, the underlying index selects companies in the S&P 500 index exhibiting a strong value score resulting from the combination of three ratios: book value to price, earnings to price, and sales to price. It is weighted by market capitalization and rebalanced annually.

VOOV invests almost exclusively in U.S. companies (98.8% of asset value), mostly in the large-cap segment (73%). The top two sectors are financials (19.1%) and technology (18.3%). Other sectors are below 12%. Compared to the S&P 500 ( SPY ), the fund under-weighs technology, healthcare and energy. It over-weighs mostly financials, industrials, utilities and real estate. As a result, the fund is better balanced across sectors than the benchmark.

As expected, VOOV is cheaper than the S&P 500 regarding the usual valuation ratios, as reported in the next table.

Source: Fidelity

The top 10 holdings, listed in the next table with weights and valuation ratios, have an aggregate weight of 26.1%. The top name, Microsoft Corp, represents 6.41% of assets. Risks related to other individual companies are quite low.

Ratios: Portfolio123

Since 10/1/2010, VOOV has underperformed SPY by 1.8 percentage points in annualized return and shows a slightly higher risk measured in maximum drawdown.

Data calculated with Portfolio123

The next chart compares the 5-year total returns of VOOV and a four passively managed large-cap value funds tracking various indexes:

• iShares Russell 1000 Value ETF ( IWD ), reviewed here ,
• Invesco S&P 500 Pure Value ETF ( RPV ), reviewed here ,
• Fidelity Value Factor ETF ( FVAL ), reviewed here ,
• First Trust Large Cap Value AlphaDEX Fund ( FTA ).

VOOV is leading the pack, almost tie with FVAL. In 2023 to date, FVAL is ahead by a short margin:

Comparing VOOV with my Dashboard List model

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 VOOV performance since 10/1/2010 with the Dashboard List model, with a tweak: the list is reconstituted quarterly instead of once a month to make it comparable to a passive index.

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

The Dashboard List outperforms VOOV by 2.3 percentage points in annualized return. However, ETF performance is real, and my list simulation is hypothetical.

Price to book: a risky concept of value

Most value indexes mixing various ratios to rank value stocks have two weaknesses, and the S&P 500 Value Index 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 and industries. Obviously, they are not: my monthly dashboard here shows how valuation and quality metrics may vary across sectors. A few ETFs have a more sophisticated approach, like Fidelity Value Factor ETF ((FVAL)) and some actively managed value funds.

The second shortcoming comes from the price/book ratio (P/B), which adds some risk in the strategy. Historical data show that a large group of companies with low P/B has a higher volatility and deeper drawdowns than a same-size group with low price/earnings, price/sales or price/free cash flow. The next table shows the return and risk metrics of the cheapest quarter 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

Vanguard S&P 500 Value ETF selects large-cap stocks with value characteristics based on book value to price, earnings to price, and sales to price. It is better diversified across sectors than the parent index, S&P 500. It has lagged SPY since 2010, but this period was mostly a huge bull market fueled by growth stocks: most value-oriented strategies have underperformed. Value style might outperform in a bear market, like it did in 2022. VOOV may be used as a long-term investment, but also as a component of a tactical allocation strategy, switching between growth and value styles based on relative strength indicators. I see two shortcomings in most value indexes: they rank stocks regardless of their sectors, and they rely too much on the price-to-book ratio.

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