As dinosaurs evolved into birds, value investors became quality investors.
The archaeologist in Steven Spielberg’s blockbuster Jurassic Park, Dr Alan Grant, believed that dinosaurs never died out as such – they simply evolved into birds.
While the dinosaurs definitely did die off, Dr Grant was also partly right: many of the dinosaurs that survived the asteroid strike later evolved into birds. (For anyone wondering what the dinosaurs looked like, check out the cassowary, pictured above. Most dinosaurs, including velociraptors, had feathers).
Something similar we might say has happened with value funds. Value investing – as classically conceived – has gone the way of the dinosaurs. What value managers have survived have evolved into quality funds, much like the dinosaurs that survived the asteroid strike evolved into birds.
Which is where today’s listing comes in.
BlackRock is listing yet another US large cap value fund. (The company has five US large cap value funds listed in the US). And listing something that looks first and foremost like a quality tracker.
The iShares Focused Value Factor ETF (FOVL), which will list on US exchanges, starts with the Russell 1000 index. It then uses a series of quality filters to weed out stocks that might be value traps.
These are: excluding top 10% most volatile; excluding the top 10% with the most leverage; and excluding those with “negative sentiment scores” -where analysts believe earnings per share in the next year or two may be bad.
What companies remain are then ranked based on a weighted composite score of four value metrics: PE, PD, PB and PCF. The top 40 ranked stocks are then equally weighted. The index will be reviewed monthly.
Analysis – advisors and ETF providers both prefer closet trackers
BlackRock already has several US large cap value ETFs. All of which are simply closet trackers, exhibiting correlations with their market weighted counterparts of 0.95 or greater. (Amusingly, the iShares MSCI EAFE Value ETF (EFV) has had a correlation of 0.99 with its plain vanilla counterpart IVE.)
This may make BlackRock sound like a miserable failure when it comes to value investing. But on the contrary: it isn’t.
There is a strong business logic to putting out closet trackers. For one, advisors – BlackRock’s target market – have a clear preference for them, as deviating too far from benchmark comes with the risk of losing clients. (Our analysis shows a correlation between closet tracking and AUM). For two, closet trackers mean more profits for BlackRock, as they’re cheaper to run than “real” value funds and come with higher margins than openly market weighted index trackers.
Yet with FOVL, BlackRock seems to be doing something new. And decided to list a quality factor fund instead of a closet tracker. FOVL only holds 40 stocks, meaning its stock bets are relatively concentrated. It equally weights them, as the academic literature says factor funds should. And it includes some clever screens to weed out value trap stocks. All that seems to be missing, so far as factor funds go, is the short selling.
Will advisors pick this type of fund up? We’ll have to wait and see. In the meantime, this is an interesting listing.