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The Fidelity Value Factor ETF (NYSEARCA:FVAL) is intended to offer targeted exposure to a portfolio of attractively priced U.S. companies screened through a rules-based strategy. Impressively, FVAL has outperformed several benchmark “value” ETFs since its fund inception data back in 2016, including through the ongoing rally that has lifted shares to an all-time high.
At the same time, we want to bring attention to the current portfolio composition, which stretches the meaning of what some may consider to be traditional value-type stocks.
While investors likely won’t complain, it is clear to us that a component of growth explains the bulk of its outperformance in recent years. Overall, FVAL is a high-quality ETF, but may not be the “value” fund investors are seeking.
What is the FVAL ETF?
FVAL is part of Fidelity’s “Smart Beta” series of funds, which goes beyond indexing by incorporating additional factors into the security selection process. In this case, metrics like free cash flow yield, EV to EBITDA, Tangible Book Value to Price, and a forward P/E multiple are considered starting with “The Russell 1000 Index” as the universe of eligible stocks.
Simply put, FVAL’s tracking index scores stocks based on these measures with the top-ranked names by sector included in the fund. The final market-cap weighting features a size adjustment to limit concentration.
source: FVAL
What stands out here is that this particular methodology differs from a comparable fund like the Vanguard Value ETF (VTV) which considers the dividend yield in the selection process as an important metric to determine “value”.
Often, these terms are open for interpretation and what we can say is that FVAL goes in a different direction with factors like free cash flow yield being highlighted, and the forward earnings multiple considered over the more common trailing twelve months earnings multiple metric.
Going through the current FVAL portfolio, we find an assortment of high-profile large-caps among the top-10 holdings including names like Microsoft Corporation (MSFT), Apple Inc. (AAPL), Alphabet Inc. (GOOGL)(GOOG), Amazon.com, Inc. (AMZN), and Meta Platforms, Inc. (META) collectively representing 25% of the fund.
While we can all agree these are ‘great’ companies and high-quality stocks, they do not necessarily scream out value in the traditional sense to us.
The data we’re looking at suggests FVAL has a 36% concentration in ‘large-cap growth’ by most classification measures. This compares to just 9% in VTV. FVAL’s dividend yield at 1.7% is also lower than VTV’s at 2.4%.
Notably, none of those 5 “Mag 7” stocks are included in the Vanguard Value ETF, where names like Berkshire Hathaway Inc. (BRK.B), JPMorgan Chase & Co. (JPM), and Exxon Mobil Corporation (XOM) take a more prominent role.
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What we’re getting at here is that a comparison between FVAL or any other value ETF almost becomes an apples-to-orange comparison because the fund strategy is so different.
Investors that hold a broad market large-cap ETF, such as the SPDR S&P 500 Trust (SPY), would already have significant exposure to MSFT, AAPL, GOOGL, AMZN, and META. Adding a position to FVAL nearly defeats the purpose of diversification, or negates an attempt to tilt factor positioning toward a separate corner of the market.
We can look at those mega-cap leaders and recognize that most have been big winners over the past, with a case to be made that they were indeed undervalued last year, our call is that we’d like to see a rebalancing.
On that point, while FVAL has beaten out value-factor ETF, it doesn’t quite match up to the actual S&P 500 or even the iShares Russell 1000 ETF (IWB), which is based on the index FVAL uses to screen out companies. Over the past year, FVAL’s 17% total return trails the 22% gain from SPY and 21% return of IWB.
What’s Next For FVAL
With a bullish view on stocks, there’s a good chance FVAL will be trading higher by this time next year. The backdrop of resilient economic conditions, while inflation has trended lower, should continue to represent a positive operating and financial environment for most companies. While there is some uncertainty on the timing and pace, expected Fed rate cuts later this year should also provide a boost to financial market conditions.
That being said, we don’t recommend FVAL as a “value” ETF, considering its particular portfolio composition and indexed methodology go beyond the spirit or ideal of what the factor should represent, in our opinion.
Investors seeking to reduce portfolio volatility or concentration away from mega-cap tech leaders will need to look elsewhere into sectors that may be out of favor today but have the potential to outperform through the next market cycle.
Final Thoughts
In a market with thousands of ETFs, some are better than others, at capturing a particular exposure, strategy, or theme. FVAL is an otherwise high-quality fund but blurs the line of what most investors consider to be a value fund. A close look is required for investors to understand what they’re getting and whether that can make sense in the context of their existing investment objectives.
