Value ETFs Don’t Really Live Up To Their Name

Value ETFs Don’t Really Live Up To Their Name

Value ETFs Don’t Really Live Up To Their Name by George Athanassakos, The Globe And Mail

Academic studies have shown that, on average since 1980, value stocks have beaten growth stocks by about 10 per cent in Canada and, depending on the market, by between 6 per cent and 10 per cent in the U.S. The figures are smaller since 1998, but still significantly positive.

But this evidence does not square with the differences in returns between U.S. and Canadian value and growth exchange-traded funds. For example, XCV-T, the iShares Canadian Value ETF, has had an average annual return of 5.7 per cent, while XCG-T, the iShares Canadian Growth ETF, has had an average annual return of 6.5 per cent, since inception in 2006.

In the United States, the corresponding returns for IUSV-N, the iShares Core U.S. Value ETF, and IUSG-N, the iShares Core U.S. Growth ETF, are 6.5 per cent and 9.2 per cent, over the same period. The growth ETFs have actually performed better. What is going on? Does value investing work or not? It all depends on how one defines value and growth investing.

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Investors widely use the terms value stocks and growth stocks, but many don’t know what they mean. Academic researchers sort stocks by price-to-earnings (P/E) or price-to-book (P/B) or other valuation metrics, and form a number of portfolios from the sorted stocks. They call the lowest P/E stocks “value stocks” and the highest P/E stocks “growth stocks.” While academicians don’t know which stocks from the value group value investors will buy, they know that they choose stocks from the lowest P/E group and avoid stocks from the highest P/E group. ETFs only roughly adhere to this rule.

But value investing is more than that. Sorting by P/E, or examining other metrics, is just the first step in the value-investing process. Next, investors value each of the lowest P/E stocks to find their intrinsic value. Finally, they compare the intrinsic value of each stock with the market price. If the stock price is less than the intrinsic value by at least a margin of safety (normally around 33 per cent of the intrinsic value), the stock is considered truly undervalued and it’s worth investing in.

Value ETFs do not meet the value requirements for either value investors or academics. They do not have a P/E, say, of less than 14-times, a price-to-book of less than 1.3-times and market cap of less than $400-million in Canada and less than $1-billion (U.S.) in the United States.

See full article here by The Globe And Mail

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