Factor-Based Investing Continued

IndexUniverse recently profiled two relatively new value ETFs (TILT and VLU):

Who needs another value-oriented ETF? Maybe you.

SSgA launched the SPDR S&P 1500 Value Tilt ETF (NYSEArca: 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 (NYSEArca: 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.

This is good news that more factor-based ETFs are coming to market.  In fact, I hope to see even more variations of value-based ETFs launched because it presents a great opportunity for investors who are looking to diversify by return factors as opposed to by style box.  Our criticism of style box investing is that, because style boxes tend to be highly correlated, the diversification benefits are limited.  Readers can click here to read different articles that we have written over the years about the potential benefits of combining relative strength (a trend continuation strategy) and value (a mean reversion strategy).

There isn’t yet much price history for VLU, but TILT has now been out for over a year.  Using monthly returns, I was interested to see that PDP (DWA Technical Leaders ETF) and TILT have had a correlation of excess returns of -0.07.  Not bad, but I look forward to finding value ETFs that have an even lower correlation of excess returns to relative strength.  Finding different winning return factors that also have negative correlation of excess returns looks to be very promising for investors who are seeking to build diversified portfolios.

See www.powershares.com for more information about PDP.


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