This year has presented investors with many surprises. As we near the end of the year, there may be one more—a rebound in value stocks.
Growth stocks, especially Big Tech and other beneficiaries of a pandemic economy, have driven the market’s 11% rise so far this year. Positive news about potential Covid-19 vaccines has ignited hopes for a more-normalized life returning in 2021, and boosted investors’ confidence in an economic recovery. Global stocks rallied over the past two weeks, and value stocks—those that typically trade below average on metrics like price-to-earnings and price-to-book ratios—have especially shot up.
Value stocks typically outperform coming out of recessions. That’s especially true this year, because their earnings have been hit particularly hard, making them easier to beat next year. Growth companies, meanwhile, benefitted from the pandemic and have a higher bar to meet, says Nick Kalivas, senior equity product strategist at Invesco. Value’s decade-long underperformance also means the group has rarely been this cheap—the Russell 1000 Value index trades at 15 times forward earnings, versus the 28 times of the Russell 1000 Growth index—a good position for long-term reversal.
Since value stocks are often financially less sound—with lower revenue, higher debt, or tighter cash flow—a broadly diversified fund can help reduce the risk if some holdings flop. “These funds’ primary defense mechanism against catching the falling knife is diversification,” says Ben Johnson, director of global ETF research at Morningstar.
Johnson favors broad index funds, and given the breadth of the rebound, a good mix of value stocks will likely benefit. Investors looking for the most value in value stocks should look to small-company stocks, which have seen bigger gains than large-caps lately. In the first three weeks of November, seven of the 10 best-performing value funds are in small-caps. The $2.5 billion SPDR Small Cap 600 Value (SLYV) and $607 million Vanguard Small-Cap 600 Value (VIOV), for example, returned 18% in November. Both funds own about 450 out of the 600 small-company stocks that tilt toward value, and charge an expense ratio of 0.15%.
The $136 million Invesco S&P SmallCap 600 Pure Value (RZV) has a more concentrated portfolio, with just 141 holdings. The fund selects and weighs stocks based on value metrics, which means the cheaper a stock is, the bigger the position is has in the portfolio, regardless of its market value. The portfolio therefore looks much different from the broader market—and not surprisingly, bounced back more—compared to other funds that weigh holdings by market value.
“Many of the value funds that had the best returns over past few days were the ones with the most potent value exposure,” says Johnson. “These stocks were hit the hardest by the Covid crisis, and they also have the most to gain from a potential vaccine and return of some normalcy.”
The $158 million American Century STOXX U.S. Quality Value (VALQ) invests in larger companies; nearly half its portfolio is in large-caps. It invests in high-quality companies with sound fundamentals that are selling at attractive valuations, aiming to avoid the riskier bets that are cheap for a reason. The fund also pays a rich dividend yield of 2.45%, which could help mitigate risks if value stocks fall out of favor again.
The $91 million Invesco S&P SmallCap Value with Momentum (XSVM) aims to capture the cheaper stocks with recent price momentum. The fund has returned an annualized 10.5% over the past 10 years, beating its sister, the SmallCap 600 Pure Value ETF (RZV) by more than three percentage points each year.
Write to Evie Liu at [email protected]
