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Value ETFs May Get Their Day In The Sun

ETF Professor

Given all the talk about market volatility this year, it might be surprising for some investors to learn that the momentum factor has outpaced the value factor.

For example, the Russell 1000 Value Index is being soundly thumped by the S&P 500 and the Russell 1000 Growth Index. Taking the comparisons even further, investors can parse through the world of exchange funds and find a number of growth and/or momentum offerings that are easily beating value equivalents. A good example is the PowerShares Dynamic Large Cap Value Portfolio (NYSE: PWV) being down 6.8 percent year-to-date while the PowerShares DWA Momentum Portfolio (NYSE: PDP) is off just 0.4 percent.

Part of the value factor's problem this year has been the Federal Reserve. Financial services and utilities names are value residents and those sectors have been plagued by speculation regarding when the Fed will raise interest rates or if the central bank can even make that move anymore. When Treasury yields climbed, financials got a lift, but utilities were hampered. The opposite was true when yields fell, but the result has been less-than-impressive performances for sector ETFs tracking financials services and utilities stocks.

“Value stocks tend to find favor when interest rates are rising. This makes sense then you consider that rates often rise behind strong economic growth, which typically benefit cyclical sectors like energy, industrials and financials. We have been in a zero interest rate environment since 2008, but given the correlation between value shares and interest rates, it would stand to reason that value shares could benefit should the Federal Reserve decided to take a less accommodative approach to monetary policy,” said Invesco PowerShares, the fourth-largest U.S. ETF issuer, in a note out Wednesday.

Although the aforementioned PWV, a $957.3 million ETF, has struggled this year, that fund has the potential to be a solid rising rates play. While PWV allocates a combined 21.5 percent of its weight to rate-sensitive utilities, telecom and consumer staples stocks, historically three of the worst-performing sectors following Fed liftoff, PWV's cyclical exposure is robust enough to endure rising rates. For example, the ETF devotes a combined 36 percent of its weight to technology, energy and consumer discretionary names.

“It’s been a rough ride for value investors, but there is reason for optimism. Within the consumer discretionary sector, analysts surveyed by Bloomberg are expecting strong third-quarter earnings growth from retailers and automakers to the tune of 14.0% and 30.2%, respectively, while the real estate industry is expected to provide a boost to financial stocks,” adds Invesco PowerShares.

Consumer discretionary is this year's top-performing sector with a healthy lead over second-place healthcare. Investors looking to access discretionary stocks via a broad market ETF with a value tilt can consider the $4.1 billion PowerShares FTSE RAFI US 1000 Portfolio (NYSE: PRF).

Viewed in some circles as one of the godfathers of the smart or strategic beta movement, PRF selects its 1,000-plus holdings based on book value, cash flow, sales and dividends. Consumer discretionary is PRF's third-largest sector allocation at a weight of 11.6 percent.

PRF has outpaced the S&P 500 in four of the past six years.

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