Value stocks have returned to form recently meaning they may soon be added to momentum indices.
Value stocks have seen a return to form in recent months. Since the start of the year, the MSCI World Value index, in sterling terms, has given investors a total return of 7.9%. In contrast, the MSCI World index has returned 3.7% and the MSCI World IMI Growth index 0.5%.
The outperformance of value stocks is a reversal of the past decade’s trend, in which value hugely lagged both the broader market and growth stocks.
Behind this rebound in the performance of value is the so-called reflation trade. Value stocks are often cyclical businesses, meaning their performance is highly sensitive to the broader economic climate. As a result, since the announcement in November of several successful vaccines, value stocks have started to outperform.
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Compounding this was the election of Joe Biden as US president in November. Markets correctly anticipated that the Biden administration would push for a big fiscal spending package, which many expect to be positive for economic growth. Indeed, since November the MSCI World Value Index has returned almost 22%.
Value stocks, however, may be about to get another boost. As Cormac Mullen, an editor at Bloomberg News points out, 23 March will mark the one-year anniversary of value stocks hitting an eight-year low, measured by the MSCI All Country World Value index. Meanwhile, 6 May will mark another low point for value stocks. On 6 November, just before the vaccine announcement, value stocks reached their relative lowest point to growth stocks.
This is potentially good news for value stocks. Momentum indices, such as the MSCI World Momentum index, choose their members based on a combination of six and 12-month performance. Momentum indices try to replicate the momentum factor, with the basic idea being that stocks that have shown strong performance in the past are likely to continue to do so in the near-term future. Therefore, momentum indices add stocks that have demonstrated strong performance over certain time frames.
As a result, many of the value stocks that have performed very strongly over the past few months should soon start to be added to the momentum indices. That will mean that any index fund or ETF tracking these indices will have to buy these stocks. According to Mullen, ETFs tracking momentum index strategies have around $20 billion (£14 billion) under management in the US alone. All this extra buying, some hope, will further boost the performance of value stocks.
“There is a significant overlap emerging between deep value stocks and momentum stocks - there are a number of autos, banks, materials, and energy stocks which are screening as both value and momentum,” says Bernstein strategist Sarah McCarthy, quoted in Bloomberg. “This is the holy grail of quant and value investing.”
Which value ETFs?
For those looking to invest in value stocks, there are several options based on your conviction in the trade.
The iShares Edge MSCI World Value Factor ETF (LSE:IWVL) and the Xtrackers MSCI World Value ETF (LSE:XDEV) are both what you could call ‘aggressive’ value options. These ETFs track the MSCI World Enhanced Value index, meaning they are much more concentrated bets on value stocks. As a result, when value stocks do well, stocks in this index usually do very well, making it a ‘high conviction’ bet on value.
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For example, since November the MSCI World Enhanced Value index has returned 31% compared to 22% for the MSCI World Value index. Year-to-date, the enhanced index has returned 13.4% compared to 7.8% for the MSCI World Value. However, this swings both ways. When value stocks underperform, the enhanced index does particularly badly.
According to Dimitar Boyadzhiev, a senior analyst for manager research and passive strategies at Morningstar, the Invesco FTSE RAFI All World 3000 ETFs (LSE:PSRW) offers more moderate exposure to value for those with slightly less conviction. He says: “FTSE RAFI indices achieve exposure to value by weighting constituents according to their dividend yield, free cash flow, total sales and book equity value. This ETF would be an option for investors with a more conservative risk profile.”
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