Refreshing the Value Proposition Can Include Being a Contrarian, And That's Alright

As was widely documented, the value factor disappointed during much of the recently ended bull market. And no, the margins by which value trailed growth weren't even close, prompting some market observers to say investors ought to just put a fork in value and look elsewhere.

For many investors, tapping factors via exchange traded funds is the way to go, but many value ETFs use antiquated approaches that may exacerbate the factor's current struggles. For example, the S&P 500 Value Index evaluates value based on book value to price ratio; earnings to price ratio; and sales to price ratio.

That's a standard, old school methodology, but investors searching a refreshed view on a once beloved investing style may want consider a more unique approach with the Principle Contrarian Value Index ETF (PVAL).

PVAL tracks the Nasdaq U.S. Contrarian Value Index, a benchmark where the objective isn't just finding inexpensive stocks. Rather, the index's aim is to focus on book yield in an effort to unearth deep value plays, which can potentially provide a more compelling short-term payoff than is typically associated with old guard value funds.

Don't Fall for Traps

The primary aims of value investors are to identify credible value while avoiding “value traps” or those beaten companies that are cheap for a reason. However, due to their prosaic underlying methodologies, many traditional value ETFs hold some companies that are in fact value traps. PVAL does a better job of averting these possible train wrecks.

“Beginning with the constituents of the Nasdaq US Large Mid Cap Index, the index methodology ranks all Financials separate from non-Financials (excluding Utilities) stocks on book yield (i.e., book value divided by price) for the most recent 28 quarters, and calculates the median book yield of the benchmark,” said Nasdaq Global Information Services product development specialist Mark Marex in a recent note.

Energy, materials and real estate are examples of sectors were value traps can currently be found, but those groups combine for just over 13% of PVAL's roster. That's a slight underweight to those groups relative to the Russel 1000 Value Index.

“Financials are materially over-weighted via standard Value metrics, as are firms in the Oil & Gas space, while Technology firms are materially under-weighted,” notes Marex. “Separately, Utilities make up 5% of the total weight in the Nasdaq US 500 Large Cap Value Index.”

Regarding technology, a sector not often thought of as value, PVAL's weight to that group is nearly 15%, or more than double the Russell 1000 Value Index's exposure to that sector.

Secret Sauce

Integral to the PVAL advantage is how the Nasdaq U.S. Contrarian Value Index responds to shifts in market conditions vis a vis book yield.

“If the most recent median book yield of the benchmark is greater than 2 standard deviations plus the average of the median for the last 28 quarters, the market condition is classified as a 'bear market'; otherwise, it is classified as a 'normal market,' said Marex.

In other words, in normal markets, PVAL will tilt toward higher quality companies, but in book yield bear markets, the fund can lead toward lower quality fare in search of deeper value with larger near-term return prospects.

Bottom line: PVAL's treatment of financial and non-financial stocks, exclusion of utilities and responsiveness to shifting market conditions can provide investors with a better value mousetrap.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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