Who needs another value-oriented ETF? Maybe you.
SSgA launched the SPDR S'P 1500 Value Tilt ETF (VLU) in late October, bringing a second choice to a somewhat-overlooked corner of the U.S. equity space.
VLU, along with the more-established FlexShares Morningstar U.S. Market Factor Tilt ETF (TILT), aren’t your typical value funds. VLU just launched and TILT is a $150 million fund that came to market about a year ago.
The typical style fund sorts the equity universe into value and growth stocks using fundamental ratios. These ratios can include price-to-earnings and price-to-book among others. But, the most basic distinction is that the typical value funds hold some stocks but not others. For example, an S'P 500 value fund might hold about 250 stocks.
Funds like VLU and TILT use a different approach. They hold all of the stocks in the universe but give the value stocks more weight.
On the face of it, this strategy sounds like it produces a watered-down value fund with imprecise exposure.
But in my view, these funds make sense as a single-fund solution for long-term value investors who also believe that completely ignoring half of the market makes little sense.
The tilt approach is consistent with the Fama-French model for stock valuation that says market risk or beta is the dominant risk factor, but that size and style also play a role.
The implication is that investors should consider size and style—specifically, a bias to value and smaller stocks—but should also own the total market.
In theory and in practice, this means that a value-tilt fund will hold a growth stock like Apple, whereas a plain-vanilla value fund won’t.
Tilts In Your Portfolio
Of course, one can get total market exposure with a value tilt by simply combining a total market fund with a value fund. ETFs are supremely modular, so mixing and matching allows for tailoring the size of the tilt and trimming it over time.
VLU and TILT offer the convenience of this kind of exposure in one bundle. While they give up flexibility, the bundled nature of these tilt funds enforces a kind of discipline that keeps investors from too-frequent adjustments while still providing an ongoing rebalance to keep the planned exposure in line.
Since today’s investors have to look outside of U.S. equities too, keeping the domestic stock exposure simple and stable also has merit.
VLU and TILT is not quite an apples-to-apples comparison:Firm-size is the difference-maker.
TILT actually delivers two tilts, not one. It’s designed to lean toward value but also toward small-caps. This combination is consistent with the Fama-French model mentioned above. TILT pulls no punches with its size bias:Roughly a third of the fund’s exposure is in small-caps.
In contrast, VLU’s small-cap exposure is much more like that of the broad market:less than 10 percent.
While VLU is too new for any meaningful performance history, I’d expect it to be less risky than TILT. The latter’s small-cap bias drives up its beta, so it will lead in up markets and lag in down markets.
The “tilt” approach to value shows up in the funds’ sector exposure. A typical value fund is heavy on financials—roughly 25 percent—with energy, health care and industrials looming large, too.
While financials also make up the largest part of the basket for both VLU (20 percent) and TILT (19 percent), consumer cyclical and tech stocks are also leading sectors for each fund. These two sectors are leading components of the broad total market. Specifically, VLU leans toward consumer cyclicals and TILT favors technology.
VLU’s youth shows up in low assets under management and thin liquidity to-date. Again, the fund has only been trading for a few weeks and had the misfortune of launching a few days before Hurricane Sandy shut down markets for two days.
Still, these two funds are meant for buy-and-hold exposure, not as trading vehicles. This means that VLU’s weak tradability in these early days shouldn’t be a deal-breaker for long-term investors. That said, use limit orders set close to intraday net asset value (iNAV) if trading either fund.
TILT has the edge on fees as well, charging 27 basis points to VLU’s 35 basis points.
Still, while neither of these expense ratios is cheap by today’s standards, the 7 basis point fee difference shouldn’t be a factor in choosing between the two funds, in my view.
In the end, their performance differences will matter a lot more.
At the time this article was written, the author had no positions in the securities mentioned. Contact Paul Britt at firstname.lastname@example.org.
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