In 1993, Nobel laureates Eugene Fama and Kenneth French published their landmark study “Common risk factors in the returns on stocks and bonds.” In this study, Fama and French proposed a new “three-factor model” of equity returns, one capable of explaining why certain stocks were statistically more likely to outperform the market.
After conducting rigorous statistical tests, Fama and French found three variables, or factors, that could explain most of the variation in investment returns. The first one was the market factor — that is, investors who buy and hold stocks take on more risk, and thus are compensated with higher returns over the risk-free rate, such as the yield on a savings account.
The other two factors proposed by Fama and French were size and value. According to the study, undervalued stocks and those with smaller market capitalizations were both more likely to outperform their larger and overvalued peers. According to the theory, investors could therefore beat the market by focusing on smaller and undervalued stocks.
Fama and French’s research opened up new avenues of exploration for fund managers, who were now able to systematically target factor exposures like value. Previously, successful value investing was relegated to a handful of stock pickers like Benjamin Graham and Warren Buffett, who used their own proprietary techniques and valuation methodologies.
Today, numerous large firms like Vanguard and Blackrock have launched multiple exchange-traded funds, or ETFs, that deliver affordable and transparent value exposure. There are also specialist firms like Dimensional Fund Advisors and Avantis Investors that focus on factor investing, with the former benefiting from a consulting relationship with French himself.
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Not all value ETFs are created equal, however. Depending on their methodologies, holdings and strategies, different ETFs can deliver varying levels of value-factor exposure.
Here’s what the experts recommend for those looking to add a value ETF to their portfolios:
| Value ETF | Expense Ratio |
| SPDR S&P 600 Small Cap Value ETF (ticker: SLYV) | 0.15% |
| Roundhill Acquirers Deep Value ETF (DEEP) | 0.8% |
| Vanguard Value ETF (VTV) | 0.04% |
| Vanguard High Dividend Yield ETF (VYM) | 0.06% |
| Dimensional US Targeted Value ETF (DFAT) | 0.28% |
| Avantis US Large Cap Value ETF (AVLV) | 0.15% |
| JPMorgan Active Value ETF (JAVA) | 0.44% |
Why Target the Value Factor?
“Fama and French define value as a lower price-to-book ratio compared to sector peers, but in practice, there are a number of different ways investors define value risk factors,” says Anessa Custovic, chief information officer at Cardinal Retirement Planning Inc. “The general idea is that value stocks are underpriced and cheap, so if you find those now and purchase them you would likely experience higher returns,” Custovic says.
That being said, the higher returns from value stocks aren’t guaranteed. “Factors in general tend to be cyclical in nature when it comes to performance, so it’s really time-period dependent,” says Brandon Clark, senior vice president and director of ETF business at Federated Hermes. Over the last decade, growth stocks have outperformed value, largely thanks to the U.S. tech sector.
“The interesting thing about growth versus value is that market preference between the two can persist for many quarters or even years,” says Kendall Dilley, portfolio manager at Vineyard Global Advisors. “The market has gone through alternating and prolonged periods of growth outperformance (1995-2000 and 2006-2020) and value outperformance (2000-2006 and 2021-present),” Dilley says.
But over longer time frames, value stocks have historically won. From 1972 to the present, U.S. large-cap value stocks still maintain an edge over their growth counterparts, returning an annualized 11.1% over this period compared to 10.1%. In 2022, value stocks held up quite well, losing just 2.2% compared to the 33.2% drawdown suffered by growth stocks.
“During periods of higher inflation and interest rates, the value factor has historically outperformed the broader market, as it did during 2022,” says Daniel Dusina, director of investments at Blue Chip Partners. “Similarly, at the start of a new business cycle, like the end of a recession, value has typically outperformed the broader market,” Dusina says.
Why Use an ETF for Value Investing?
Enterprising value investors can utilize online stock screeners to filter for stocks with value characteristics, but managing a portfolio of a dozen or more value stocks can be time consuming and expensive for non-professional investors.
To go hands-off, consider value ETFs, which provide exposure to a basket of value stocks within a single ticker. Like stocks, ETF shares trade on exchanges throughout the day, making it easy to buy and sell. Because most ETF providers update their holdings on a daily basis, you can easily keep track of what value stocks they’re holding.
“ETFs are a great way of gaining exposure to the value factor because it’s difficult to identify it,” Custovic says. “You need a lot of fundamental data and intensive bottom-up analysis to identify a potential value stock, and most retail investors don’t have the expertise or time to do this,” she says.
“My experience has been that value-factor ETFs tend to be used as a ‘satellite’ investment in a portfolio to achieve a certain objective,” says Clark. For example, an investor could hold an S&P 500 ETF at 80% of their portfolio and augment it with the SPDR S&P 600 Small Cap Value ETF (SLYV).
This combination provides an additional 20% exposure to the 455 stocks held in the S&P Small Cap 600 Value Index, which are screened for low price-to-book, price-to-earnings and price-to-sales ratios. These stocks are not part of the S&P 500 index and could help the portfolio outperform over time.
Using ETFs also allows investors to combine multiple factors, with a potent combination being small-cap value. “I believe small caps have the greatest potential when it comes to value simply because they are less well known,” says Kurtis Hemmerling, a freelance fundamental quantitative portfolio designer.
“However, small caps are risky, so you need to separate value traps from good value,” he says. Hemmerling suggests focusing on small-cap value stocks that have positive free cash flow; low short interest; and low price-to-free-cashflow, price-to-sales and price-to-earnings ratios.
“If I had to pick a small-cap value ETF, I would without hesitation select the Roundhill Acquirers Deep Value ETF (DEEP),” Hemmerling says. “I have a soft spot for DEEP because the average weighted market cap of its holdings is smaller at $1 billion, and the majority have positive free cash flow,” he says. DEEP holds a concentrated portfolio of 99 stocks and charges a 0.8% expense ratio, or $80 annually per $10,000 invested.
[SEE: 10 ETFs to Build a Diversified Portfolio.]
What to Look For in a Value ETF
Value ETFs generally fall into three categories: passive funds that track an external value benchmark index, “smart-beta” funds that use a quantitative, rules-based screener, and actively managed funds that pick value stocks according to a fund manager’s proprietary strategy.
“If you are looking at a long-term, buy-and-hold retirement investment, consider a passive value ETF,” Custovic says. “These will track an index and have lower fees than an actively managed ETF,” she says. A great example is the Vanguard Value ETF (VTV), which tracks the CRSP US Large Cap Value Index. VTV is extremely cost effective with a low expense ratio of just 0.04%.
For those also looking for better yields, Dilley recommends also considering dividend-focused ETFs. “Dividend-paying stocks often fall into the value category and can benefit from rising rate environments,” he says. Dilley suggests the Vanguard High Dividend Yield ETF (VYM), which shares many similar characteristics as VTV.
To start with, VTV and VYM both fall into the “large-cap value” section of the equity stylebox. Both ETFs also share significant holding overlaps when it comes to large-cap value stocks like Exxon Mobil Corp. (XOM), Johnson & Johnson (JNJ), Procter & Gamble Co. (PG) and Chevron Corp. (CVX).
But not all experts prefer passive value-index ETFs. “For value, we recommend caution with passive options that provide broad exposure, as it could result in exposure to stocks that are cheap for a reason, whether due to leverage, industry composition or operational challenges,” Dusina says.
An alternative here is a smart-beta ETF that uses rules-based screeners to pick value stocks with solid fundamentals. Unlike passive ETFs, smart-beta ETFs don’t always follow an index. They’re not truly actively managed either, given that the stock selection process is objective based on metrics defined in a quantitative methodology.
Some popular examples of smart-beta value ETFs are the Dimensional U.S. Targeted Value ETF (DFAT) and the Avantis U.S. Large Cap Value ETF (AVLV), which charge expense ratios of 0.28% and 0.15%, respectively. Both ETFs come from firms with demonstrated expertise and track records of factor-investing success, and they use systematic screening criteria to find value stocks.
DFAT’s screener checks for value characteristics like low price-to-book, price-to-cash-flow and price-to-earnings ratios, in addition to screening for profitability and momentum factors. AVLV screens for value and profitability based on adjusted price-to-book and adjusted cash-from-operations-to-book-value ratios, respectively, in addition to checking for liquidity and market cap.
Some managers still prefer active management, however. “Smart beta can work, but since it is inherently backward looking, it’s trying to drive down the road by only looking in the car’s rearview mirror,” Dusina says. “Factors may indicate that a stock is cheap based on historical financial results, but it cannot take into account some change that may cause the next five years to look quite different,” he says.
“Given our stance, we would lean toward actively managed ETFs for value exposure,” Dusina says. An example would be the JPMorgan Active Value ETF (JAVA), which employs a proprietary, bottom-up strategy in assessing fundamentals and searching for potential value stocks. JAVA charges a 0.44% expense ratio, higher than the earlier passive and smart-beta value-factor ETFs.
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7 Best Value ETFs to Buy and Hold originally appeared on usnews.com
Update 03/09/23: This story was published at an earlier date and has been updated with new information.
