2023-08-02 07:15:00 ET
Summary
- Combining ETFs with individual stocks is a great way to maximize returns and income while minimizing the risk of catastrophic losses killing your financial dreams.
- Large-cap value is perfectly positioned to profit from a soft landing due to superior valuations and is protected by quality and size in case of a recession in 2024.
- Here are two amazing actively managed value ETFs that will likely deliver superior long-term returns because these are potential rock-star ETFs.
- Four value managers run JAVA with 30 years of average experience and has delivered about 4% historically superior returns to its benchmark, 10X its expense ratio.
- The other ETF is run by legendary fund managers no one has heard of that have a 100% track record of delivering index-beating returns for every fund they manage.
I'm always on the lookout for the world's best ETFs because those can serve as the core of a diversified and prudently risk-managed portfolio perfect for your specific needs.
Today I'd like to showcase two potentially attractive long-term ETFs worth keeping on our radar.
These are Gold-rated ETFs, according to Morningstar, meaning their analysts are confident both will be strong outperformers over time. JAVA and FUNL might even give SCHD and VTV, the gold standard of value ETFs, a run for their money and whether it's worth adding some to your portfolio.
- Note that the ratings for Morningstar are based on different criteria than what SA quant ratings use.
- SA quant ratings are focused on things like momentum (thus, QQQ is rated a strong buy despite trading at a 35% historical premium) and not valuation
- Morningstar's ratings are primarily based on the underlying ETF portfolio strategy
- this is why this article doesn't mention SA's quant ratings on these ETFs
- SA quant ratings are like technical analyst
- I am a fundamentals driven analyst
JPMorgan Active Value ETF
First, let's ensure you understand why large cap value is such a wonderful long-term strategy, especially today.
We're likely headed for a recession in 2024, and large companies have the resources to survive and thrive through the coming downturn.
And guess what? Today value is still a good deal, and everything else? Not so much.
JPMorgan Asset Management
Large-cap value is training at about 20-year average PE, while large-cap blended and growth is at a 23% and 44% premium.
For context, a 50% premium was the peak of the tech bubble in March of 2000, after which stocks spent three years falling 50% (and tech fell 82%).
Today's big tech is nothing like the no-profit tech of 2000, but the valuations are similar.
If you overpay for even God's own company by 44%, you're just begging to get slapped in the face by the market gods for your insolence and stupidity;)
JPMorgan Asset Management
So far this year, large-cap value is barely up, while growth has exploded in price and thus created one of the worst reward/risk ratios in history.
The S&P 500 has never been a less attractive investment in the last 20 years compared to bonds.
But large value is a wonderful, safe place to hide ahead of a 2024 recession without paying an insane price like what growth investors are paying.
- bubbles can always continue longer than expected
- growth bubble might inflate to new record highs like a 50% or even 60% historical premium
- 97% statistical probability that buying growth now is going to lead to poor returns in the future
For a 0.44% expense ratio, about 0.4% higher than a pure passive ETF, JPMorgan is willing to ensure that your money is invested in higher-quality companies. Their professional fund managers seek to avoid value traps. though I wouldn't necessarily call three years the sign of a value trap.
- Blue-chip bear markets for PEP, LMT, and MO (and many others) have all lasted as long as seven years.
But JPM's attempts to improve the index approach by focusing on higher quality (more profitable) companies, trading at superior valuations, and avoiding the companies their analysts consider fundamentally broken is certainly promising.
Is it worth an extra 0.4%? Time will tell, but Morningstar's analysts think it is.
JAVA isn't a high-yield ETF like SCHD or VYM. But it is designed to go head to head with 5-star gold-rated VTV, the Vanguard Value ETF, the gold standard of large-cap value ETFs.
The team is backed by David Silberman, the longest-tenured manager on the strategy, who brings over 25 years of portfolio management experience." - Morningstar
Four managers are running JAVA, averaging 30 years of industry experience and collectively 119 years.
Passive strategies are purely rules-based, like SCHD or VIG.
There is an index that runs on rules, and the ETF tracks it precisely.
Active management means humans make judgment calls, applying their expertise to determine when "this time is different," which, according to Templeton and Marks, is about 20% of the time.
In the case of valuation metrics, JAVA uses a nice mix of traditional PE, normalized earnings (for smoothing outliers), EV/EBITDA (private equity's favorite), and Free Cash Flow yield, the best-performing valuation metric of the last 30 years.
The traditional PE ratio is the most popular but the least accurate way of measuring value since 1991. At least it delivered the lowest returns though its volatility-adjusted returns were pretty good.
JPMorgan is striving for consistently better returns with less volatility. And thus far, its strategy has been working much better than the Morningstar median.
- Thus the Gold rating
For example, JPM's larger cap managers (not just JAVA but all) have delivered 111% of their benchmark's upside with 103% of the downside, a positive spread of 7.6%.
That's about 19X better than the median Morningstar value manager.
Compared to the Russell 1000 value index, JPMorgan is heavier into financials that crashed earlier in the year due to the regional banking crisis that has become far less severe than feared.
JPM's approach to overweighting financials practices good risk management, with the majority being diversified banks.
You can see that the company is bullish and overweight on BMY (I agree 7X earnings) and underweight on Cisco and JPMorgan itself!
JPMorgan's active value managers think it's not good to own JPMorgan right now;) Now that's integrity and a lack of conflict of interest!
The Russell 1000 value index is 832 companies, and JPM is selecting what it thinks are the top 20% of those value stocks.
The turnover is high; that's what you pay for with active management.
The PE of 13.5 at the end of June is highly attractive and better than the benchmark, and the 12-month consensus growth rate is 50% better.
What about long-term growth, according to Morningstar, for the current portfolio?
JAVA Fundamentals
Morningstar
Morningstar's analysts think that JAVA's 154 stocks will deliver about 13% long-term returns.
- Morningstar estimates 12% long-term returns from VTV
In other words, in exchange for JPM's expertise in active management, investors are paying 40% of the estimated alpha (gross of taxes).
- Over 30 years, JAVA's current portfolio is expected to deliver 20% better inflation-adjusted returns.
By Morningstar's estimates, JAVA has delivered 7.5% annual returns vs. 2.3% for the Russell 1000 value index and, after taxes, 6.9%.
Thus far, JAVA's extra expense ratio is 10% of the extra post-tax returns it's been generating.
- why it's a gold-rated active ETF
In the last year, JAVA's tax-adjusted returns are in the top 18% of large-cap value ETFs, and its tax-cost ratio is about as low as many passively managed ETFs.
- professional tax loss harvesting
CornerCap Fundametrics Large-Cap ETF
You've probably never heard of CornerCap.
After a decade of managing RJR Nabisco’s $4 billion retirement fund, Gene Hoots and Tom Quinn founded CornerCap to help individual investors grow and protect their wealth.
Using the proprietary Fundametrics ® investment methodology they pioneered, Gene and Tom began managing the assets of friends and family who trusted them as stewards of their wealth. This same commitment to managing clients’ money with as much care as we would advise friends and family guides the way we do business every day.
Three decades and $1.3 billion in assets under management later, our firm remains 100% employee-owned. Independent ownership preserves our ability to remain transparent and accountable to each client still today." - CornerCap
What is fundametrics?
Fundametrics is a systematic approach to fundamental, bottom-up investing that provides consistent and repeatable execution while eliminating bias and emotion from investment decision-making." - CornerCap
So basically, the investing Ben Graham taught Buffett to do has been the hallmark of all the greats, including Lynch, Greenblatt, Marks, Templeton, and of course, Graham and Buffett.
So a very Buffett-like story for this company. But do the facts back up the marketing hype?
Morningstar vouches that CornerCap is a world-class asset management team and that this ETF is very solid in construction and strategy.
According to Morningstar, the 0.5% expense ratio will likely be worth it due to superior long-term returns.
Its parent firm's impressive long-term risk-adjusted performance is the predominant contributor to the rating, as shown by its average 10-year Morningstar Rating of 4.3 stars. The parent firm's five-year risk-adjusted success ratio of 100% supports the rating....
The CornerCap five-year risk-adjusted success ratio is 100%, meaning that over the period, 100% of its products have survived and beaten their respective category median on a risk-adjusted basis ...
Their commendable success ratio suggests that the firm does well for investors and that this fund may benefit. Management team experience, which averages 31 years at this fund , also strengthens the process." - Morningstar
OK, that is some very impressive corporate fundamentals from CornerCap!
The team is backed by Jeffrey Pierce Moeller, the longest-tenured manager on the strategy, who brings over 25 years of portfolio management experience. The average Morningstar Rating of the strategies they manage is 4.0 stars , demonstrating excellent risk-adjusted performance versus category peers. Although the team is small, it is a solid supporting cast. Together, the three listed managers boast more than an average of over 30 years of portfolio management experience. As a team, they manage two investment vehicles together, with a Gold asset-weighted average Morningstar Medalist Rating , demonstrating their potential to deliver positive alpha in aggregate." - Morningstar
A rock-star team of gold-rated fund managers runs FUNL.
Currently, FUNL is very similar to the Russell 1000 value fund.
On a trailing valuation basis, FUNL is much more undervalued than its benchmark.
And through March of 2023, it was beating its benchmark by 0.82% annually, more than its expense ratio.
So far, despite a high turnover of about 60% per year, FUNL has achieved a low tax-cost ratio of about 0.5% courtesy of actively harvesting losses.
In the last year, it was in the top 27% of peers in terms of tax-adjusted returns though its historical returns of 13.8% net returns are more impressive.
Morningstar
Morningstar believes the current portfolio can have about 12% to 13% long-term returns, about 20% to 30% more than the S&P.
- about 0.5% more than VTV
- thus the gold rating on this active fund
Bottom Line: World-Class ETFs Can Change Your Life
Bar-belling your highest conviction stock ideas with wonderful ETFs is a very prudent way of managing risk and winding up rich.
Did you know that historically almost 60% of tech stocks suffer permanent 70+% crashes? Think of that the next time you invest 25% or more of your life savings into Wall Street's current tech darling;)
You do the following if you match every dollar you invest in an individual stock with money invested in the world's best ETFs.
- you ensure that you can't blow yourself up too badly if you pick the next GE
- you can boost ETF fundamentals (yield, growth, total returns) beyond what any ETF is actually capable of delivering
This is what my family charity hedge fund ZEUS Income Growth is doing.
We combine the nine best ETFs I've ever found with the highest conviction blue-chips for our specific needs and then add 33% hedges (bonds and managed futures).
Today we looked at two relatively new Gold star-rated value ETFs, which Morningstar is very confident will be the rockstars of value ETFs in the future.
Overall I'm impressed with JAVA. It's been doing its job admirably, beating its benchmark, and proven with the added 0.4% expense ratio.
I don't plan to replace my SCHD with JAVA or FUNL since SCHD is my high-yield ETF, and I prefer my value to be as deep value as I can get. But if you're looking for potentially 13% long-term returns, then Morningstar thinks this Gold-rated ETF will be a future 5-star rated champ.
If you're looking for something better than VTV for your large-cap value exposure, it looks like JAVA and FUNL are potentially great options, though it will be another year before Morningstar can give them a star rating.
For my family's charity hedge fund, I prefer my high-yield value and deep value to be as deep value as you can safely get.
That's why we don't own a value ETF. We own SCHD for core high yield and will own COWZ (deep value) and VFLO (Super GARP).
For further details see:
I Love These Amazing Dividend ETFs, And So Will You