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The more dovish narrative that has overtaken the markets since December, resulting in the S&P 500 sitting close to a fresh all-time high, means excessive value exposure might hurt returns in 2024. Obviously, this is not an opportune moment for investment vehicles like the Invesco S&P SmallCap 600 Pure Value ETF (NYSEARCA:RZV), a passively managed fund with a maximalist take on the valuation factor.
The previous time I covered RZV was in February 2023, when I emphasized that quality-agnostic strategies could backfire. And RZV’s performance since then speaks for itself.
Seeking Alpha
And even after almost a year, I believe it is unjustified to change that skeptical stance. This is not because RZV has too much value in its portfolio, which might be more of a drag amid the growth rotation. The issue here is that this vehicle comes with unnecessary quality risks that rarely translate into upbeat returns. Obviously, almost no exposure to growth stocks also hardly justifies a Buy rating. Let me elaborate on all these problems below in the note.
Recapping the strategy
With the S&P SmallCap 600 Pure Value Index as its basis, the fund offers exposure to the cheapest companies in the U.S. small-cap echelon. As described on its website,
The Index measures the performance of securities that exhibit strong value characteristics in the S&P SmallCap 600® Index. Value is measured by the following risk factors: book value-to-price ratio, earnings-to-price ratio and sales-to-price ratio. The Fund and the Index are rebalanced annually.
Factor mix: a portfolio with a goodly discount, yet there are too many quality risks
In the previous article, I addressed RZV’s earnings yield, which stood at about 8%, an undoubtedly solid figure. Alas, quality characteristics have deteriorated since then, with 37% of its 144 common-stock and REIT holdings being unprofitable at this point and Lumen Technologies (LUMN) having an EY of negative 663%, so the weighted-average EY stands at negative 2.4%, thus being useless entirely, so we should look for alternatives. One of the solutions is to use the median for the positive figures, which at this juncture is close to 9%, a fairly substantial result supported predominantly by the financial, energy, and materials sectors. Median EV/EBITDA might be helpful as well.
Weight in % (Calculated by the author using data from Seeking Alpha and the fund)
As the chart above illustrates, the RZV portfolio offers sizable discounts when it comes to all the sectors represented, except for financials, which are not covered as this multiple is not applicable for banks, insurance companies, etc.
Another useful metric is the cash flow yield (Net CFFO/Price). Since for banks and the like it is also of no use, I have applied the exact same principle that I described in the previous article: all the financials were removed, and their weights were redistributed evenly between the remaining 113 holdings. So, as of January 12, the cash flow yield stood at around 10.3% vs. 8.8% previously, which is definitely a respectable result.
However, we still need a more reliable metric—ideally, a weighted average. A method that works excellently for multi-sector mixes is applying the Seeking Alpha Quant Valuation grade. Here, RZV offers a lot. It has one of the largest allocations to companies with at least B- Valuation grade among all the value ETFs I have covered to date, over 82%. Firms that look priced for perfection, with a D+ grade or worse, have a weight of less than 5%. This can be partly explained by the fact that the weighted average market cap stands at $1.45 billion, as per my calculations; for clarity, smaller companies tend to trade with a size discount, which is mostly the consequence of the market’s perception of their ability (or inability) to successfully compete with larger rivals, resilience of their sales, etc.
So, what might be wrong? As mentioned above, RZV has intolerably weak quality. To illustrate, let us present the following chart:
Created by the author using data from Seeking Alpha and the fund. Holdings as of January 10, financial data as of January 12
Please take notice that data for LUMN, namely a negative EY of 663% and a negative ROA of 31.7%, were removed to improve the readability of the chart.
As we can see, numerous RZV’s holdings were unable to turn a profit in the last twelve months, so this does not come as a surprise that the WA Return on Assets is less than 1%, as per my calculations. We can replace all the negative figures with zero and compute ROA once again, but even in this case, the figure would be minuscule at 1.99%. The WA Return on Equity is similarly weak at 1.55%.
Next, just about 27% of the holdings have a B- Quant Profitability rating or better; those stocks with issues serious enough to justify a D- rating or worse account for about 29%. So it seems that, compared to February 2023, quality issues have become even worse.
It is also worth addressing the balance sheet risk shortly. We see that roughly 50% of the companies have Debt/Equity above 100%; in February, that figure stood at 42%. Assuming that most of these companies have low profitability, this is hardly an attractive proposition.
Ultimately, on the growth front, RZV offers a fairly bleak story, as shown below.
| EPS Fwd | Revenue Fwd |
| -4.05% | 4.45% |
Calculated using data from Seeking Alpha and the fund
For a better context, it is worth mentioning that the forward EPS growth rate is negative as pundits forecast earnings contraction for about 54% of the holdings. And even though spectacular revenue growth stories are present in this mix, like the one of EchoStar (SATS), which is forecast to more than double its sales, the weighted-average growth rate is so bleak as lower revenues are anticipated for approximately 32% of the firms represented in the portfolio.
Performance
Even though RZV had negative returns in 7 out of 12 months last year, including сatastrophic March when it lost more than 9%, it still delivered an almost 23% total return for the year, thanks to its double-digit gains in November and December. Nevertheless, this was still more than 3% lower than the total return of the iShares Core S&P 500 ETF (IVV).
Next, compared to the Invesco S&P MidCap 400 Pure Value ETF (RFV), the Invesco S&P 500 Pure Value ETF (RPV), as well as IVV, RZV has had the weakest start to 2024, with the growth rotation being the likely culprit.
Speaking about the longer term, over the April 2006–December 2023 period, RZV delivered an annualized total return of 6.97%, lagging both peers and the S&P 500 ETF.
| Portfolio | RZV | IVV | RFV | RPV |
| Initial Balance | $10,000 | $10,000 | $10,000 | $10,000 |
| Final Balance | $33,077 | $51,988 | $49,880 | $39,874 |
| CAGR | 6.97% | 9.73% | 9.48% | 8.10% |
| Stdev | 30.24% | 15.58% | 25.08% | 23.17% |
| Best Year | 62.67% | 32.30% | 59.74% | 53.51% |
| Worst Year | -41.16% | -37.02% | -43.01% | -47.79% |
| Max. Drawdown | -72.27% | -50.78% | -63.58% | -69.71% |
| Sharpe Ratio | 0.33 | 0.59 | 0.44 | 0.4 |
| Sortino Ratio | 0.51 | 0.87 | 0.66 | 0.58 |
| Market Correlation | 0.82 | 1 | 0.89 | 0.88 |
Data from Portfolio Visualizer
Final thoughts
RZV offers a value story that comes with numerous quality risks, including those related to profitability, capital efficiency, and balance sheet health. While it is obviously not guaranteed that the zeitgeist will not shift in favor of value stocks once again, as the oil price dynamics, one of the major contributors to investors’ perception of possible future inflation surprises, is already looking worrisome, I see no justification for buying into value-heavy mixes that score horribly against quality indicators. In this regard, I remain neutral on RZV; the Hold rating is maintained.
