XSVM - XSVM: Works Great With A Crystal Ball

2023-05-02 06:23:27 ET

Summary

• The XSVM ETF selects stocks that score well on both 'Value' and 'Momentum' factors.
• While returns have been good, it is mostly driven by an exceptional 2021. I fear the ETF's outperformance from 2021 is not repeatable.
• 'Value' and 'Momentum' factors can and often contradict each other, especially when 'Growth' stocks are leading the markets.
• Unless investors know a priori whether 'Value' and 'Momentum' will align, I believe they are better served investing in broad index funds without factor tilts.

The Invesco S&P SmallCap Value with Momentum ETF ( XSVM ) selects stocks that score well on both 'Value' and 'Momentum' metrics.

While the XSVM ETF had an exceptional 2021, I fear the performance may not be repeatable as 'Value' and 'Momentum' are often contradictory factors, especially when 'Growth' stocks are leading the markets.

Unless investors want to make a specific bet that 'Value' and 'Momentum' will once again be aligned going forward, I believe they may be better served investing in broad index funds without specific factor tilts.

Fund Overview

The Invesco S&P SmallCap Value with Momentum ETF selects small cap stocks that score well in both 'Value' and 'Momentum' factors.

Strategy

The XSVM fund tracks that S&P 600 High Momentum Value Index ("Index"). To construct the index, the index provider first starts with the S&P SmallCap 600 Index. Then it selects the top 240 stocks according to a 'value score'. To calculate the 'value score' for each security, the index provider evaluates each stock's book value-to-price, earnings-to-price, and sales-to-price ratios. Next, the resulting stocks are ranked by their 'momentum score'. The 'momentum score' is calculated by evaluating the stocks' price change over the prior 12 months, excluding the latest month. The highest 120 momentum scores are then selected for inclusion in the index. The components are weighted by their value score.

Portfolio Holdings

Figure 1 shows the XSVM ETF's sector allocation. Currently, the XSVM ETF is heavily invested in Industrials (23.1%), Consumer Discretionary (18.1%), Financials (17.7%), Energy (12.3%), and Materials (11.5%).

Figure 2 shows XSVM's top 10 securities, which comprise 17.9% of the portfolio.

Distribution & Yield

The XSVM ETF pays a modest quarterly distribution with trailing 12 month distribution of $0.73 / share or 1.7% trailing yield (Figure 3).

Returns

The XSVM ETF has performed very well on a 3Yr time frame, with 3Yr average annual returns of 26.0% to April 30, 2023. Longer-term 5, 10, and 15Yr average annual returns are more modest at 9.7%, 10.5%, and 8.9% respectively (Figure 4).

Investors should note that 3Yr returns may be flattered by the starting period, which was near the COVID-pandemic lows. Therefore, longer-term returns may be more representative of the strategy's return potential.

Figure 5 shows the historical returns of the Vanguard S&P Small-Cap 600 ETF ( VIOO ) for reference.

Comparing between figure 4 and figure 5, we can see that the XSVM ETF appears to have added significant alpha, when compared to the benchmark S&P 600 Index.

Analyzing XSVM's returns in more detail, investors should note that although the fund has delivered better returns than the benchmark, it has come at the expense of higher portfolio volatility, as shown by XSVM having much higher portfolio volatility compared to the Morningstar Small Value category (Figure 6).

When Value And Momentum Meet...

Looking at the macro drivers to equity returns, it is interesting that the XSVM ETF has chosen to combine 'Value' and 'Momentum' factors into a single fund.

Historically, these two factors are often contradictory, as 'Value' is usually associated with cyclical industries such as Industrials, Financials, and Energy while 'Momentum' has been more associated with 'Growth' investments within the Information Technology, Communications, and Consumer Discretionary sectors in the past few years.

However, since the COVID-pandemic, 'Value' sectors like Energy and Industrials have enjoyed a tremendous recovery, and have actually replaced 'Growth' companies within the 'Momentum' indices as they showed stronger short-term price momentum.

This alignment of 'Value' and 'Momentum' has led to dramatic performance of the XSVM ETF, which returned an incredible 56.4% in 2021, almost 30% better than the VIOO ETF (Figure 7).

...But Will This Trend Persist?

However, going forward, the question for XSVM investors is whether the recent past was an anomaly or the new normal? In other words, will 'Value' continue to lead the markets, thus exhibiting strong 'Momentum', or will 'Growth' once again lead the markets?

The problem is if we compare the annual returns of the XSVM ETF with the VIOO ETF, we can see that XSVM's outperformance in 2021 sticks out like a sore thumb (Figure 8).

Excluding 2021, the arithmetic mean return of XSVM returns from 2013 to 2020 and 2022 is 9.9% whereas the arithmetic mean return of VIOO is actually higher at 10.4%. This result makes sense because in some years, 'Value' and 'Momentum' were actually contradictory factors. In fact, studying the 10 years from 2013 to 2022, the XSVM outperformed the VIOO ETF exactly 5 out of 10 years, so the probability of outperformance is a flip of the coin.

Conclusion

While XSVM's outperformance in 2021 was eyepopping, I believe it may be due to the unusual circumstances of the post-pandemic recovery. Excluding 2021, the XSVM ETF actually underperforms the benchmark, as 'Value' and 'Momentum' factors are often contradictory, especially when markets are led by 'Growth' stocks.

Unless investors have a crystal ball that will tell them when 'Value' and 'Momentum' factors will align, I suggest they stick with broader market funds like the VIOO ETF instead where investors are not exposed to specific factor tilts.

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