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Knowledge level: Intermediate Reading time: 5-7 minutes
Value investing, which involves buying ‘beaten-up’ and ‘unloved’ stocks often trading less than their intrinsic or book value, has underperformed for years now. With central banks keeping interest rates at record lows, and global technology giants such as Apple (NASDAQ: AAPL) and Amazon (NASDAQ: AMZN) on a tear, growth stocks have thoroughly outperformed. But are things about to change?
Steepening yield curve may mean a higher discount rate
The yield curve, which plots interest rates for bonds of equal credit and different maturities, has steepened sharply in recent months. This comes as investors take stock of the coronavirus vaccine roll-out and weigh-up fears that US President Joe Biden’s US$1.9 trillion stimulus package could trigger high levels of inflation.
Source: Bloomberg as at 31 January, 2021
When interest rates rise, in theory at least, the way companies are valued changes. This is because when interest rates rise, the “discount rate”, which is the interest rate investors use to value companies’ future profits, also rises.
The higher the discount rate, the more “a dollar today is worth more than a dollar tomorrow”. And the more a company’s share price should, in theory, reflect their profits today over their profits tomorrow.
Higher discount rates can be a good thing for value stocks. This is because their valuations tend to be more heavily determined by their near-term profits. And indeed, over the past six months, as the yield curve has steepened, we have seen value stocks outperform.
Source: Bloomberg as at 31 January, 2021
Value stocks love a vaccine
Another potential signal of a value stock recovery may be vaccine roll-outs. Value stocks tend to be concentrated in sectors hit hardest by lockdowns, namely oil, utilities, travel and entertainment.
According to Goldman Sachs, these value stocks have “the highest correlation to vaccine distribution probabilities”. Said more simply, the better the chance of reaching herd immunity via vaccines, the better the chance value stocks will outperform.
The below chart from Goldman Sachs shows the sensitivity of value stocks to vaccine roll-outs in the US.
Source: Goldman Sachs Global Investment Research and GSAM. As of January 31, 2021
Yield – a real value strategy
There are many ways to define and access value stocks. But one common way is to use dividend ETFs. This is because they tend to have lower price-to-dividend, price-to-earnings and price-to-book ratios than the total market.
After all, this is what allows them to sustain their higher dividend payouts. With this in mind, investors may wish to consider the ETFS S&P 500 High Yield Low Volatility ETF (ASX: ZYUS), which offers a prospective solution to invest in the value rotation.
How the ‘ZYUS’ ETF works
The fund invests in the 50 least-volatile high-yielding S&P 500 stocks. This means that the primary filter for the index is yield, initially ranking the 75 highest-yielding stocks.
The secondary filter is volatility, removing the 25 most-volatile stocks that passed the first filter.
These rules result in a portfolio of 50 stocks that target high yield and a portfolio that has an embedded value tilt, which is particularly meaningful in the current market.
Both the profound impact of COVID-19 on high-yielding sectors and the oil crash took a large toll on the performance of the ‘ZYUS’ ETF last year. Along with the fund’s underweight exposure to the top-performing tech sector, there was a notable lag in returns throughout 2020.
However, as we start to see early signs of a rotation to value, in the last 6 months the ‘ZYUS’ ETF has begun to outperform the S&P 500 Index.
Notwithstanding ZYUS’s performance has significantly dragged over the last 12 months, particularly due to being underweight big tech versus the S&P 500, if the rotation to value continues there is potential for a continued recovery in ‘ZYUS’.
|ETFS S&P 500 High Yield Low Volatility ETF (ZYUS)
|S&P 500 Index
Source: Bloomberg as at 28 February, 2021
Despite the volatility of last year, ‘ZYUS’ has continued to be an exceptional yield play relative to broad US market exposures, and even many Australian yield exposures.
As at the end of February 2021, the ‘ZYUS’ ETF has a yield of 6.02%, which is significantly higher than the long-term average dividend yields of the All Ordinaries and broader S&P 500.
The S&P 500 Low Volatility High Dividend Index, which is the underlying index for the ‘ZYUS’ ETF, rebalances every January and July.
There were 10 stocks added and 9 stocks deleted following January’s rebalance with a one-way turnover of 25%.
The sector level changes are highlighted below, however, a detailed analysis of the rebalance is available here.
Investors looking for exposure to the rotation away from high-growth stocks to ‘cheaper’ cyclical sectors may wish to consider the ‘ZYUS’ ETF.
If you’d like any further information about the ETFS S&P 500 High Yield Low Volatility ETF (ASX: ZYUS), please contact Kanish Chugh from ETF Securities on the below details.
To invest in ASX-listed ETFs or any other ASX and US-listed securities, join SelfWealth today for flat-fee $9.50 brokerage and no other account fees or commissions!
Kanish Chugh (Head of Distribution – ETF Securities AU)
Phone: +61 2 8311 3476
Mobile: +61 4 1209 1154
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