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Key takeaways
Key points
Rethinking value investing
Traditional value strategies have often focused on a narrow group of companies identified as “cheap” using valuation measures such as price to book, price to earnings and dividend yield. However, in recent years, these strategies have experienced extended periods of underperformance as other parts of the market have driven returns.
Fundamental value takes a broader approach by selecting the largest companies in the relevant sharemarket based on the size of their underlying businesses, rather than focusing only on stocks that appear cheap under conventional valuation metrics. It then weights them according to their fundamental value.
Having managed the QOZ Australia 200 Fundamental Value ETF for over a decade, we are proud to launch the GVAL Global Fundamental Value ETF, which provides exposure to global developed markets excluding Australia.
The fundamental value approach
Rather than selecting only stocks that look cheap on conventional measures, a fundamental value strategy selects the largest companies in its market by the size of their underlying businesses, or fundamental value, and weights them by that same measure. Fundamental value uses four complementary measures:
- Sales: 5-year average sales
- Cash flow: 5-year average cash flow plus 5-year average R&D expense
- Book value: latest book value plus R&D expenses capitalised over 5 years
- Dividends: 5-year average dividends plus buybacks
Together these capture different dimensions of business size and reduce reliance on any single accounting measure. Including R&D recognises intangible investment as a significant part of a modern company’s business.
At each scheduled rebalance, the strategy generally reduces exposure to companies whose share prices have become expensive relative to their fundamentals and increases exposure to those that have become cheaper. The result is a broadly diversified portfolio with a distinct value tilt. It can still hold companies not traditionally classified as value stocks, tilted to reflect their fundamental size.
Overcoming value’s periods of underperformance
Fundamental value’s broader approach to value investing is intended to provide a more balanced return profile across different value environments.
As illustrated below, GVAL’s index has historically captured a substantial share of the upside during periods when traditional value outperformed, while experiencing less severe average declines when traditional value was out of favour. This is due to the approach of holding a broader basket of companies and not just value names in isolation.
Since May 2013, when value outperformed, GVAL’s index captured on average 89% of that upside. More tellingly, when value underperformed, GVAL’s index outperformed traditional value by, on average, 4.3%. In other words, it captured only 66% of the underperformance.2
GVAL’s index has trailed MSCI World ex Australia since May 2013, returning 13.8% p.a. against 14.2% p.a., in a period of strong broad market returns led by mega-cap US technology stocks. Over this period GVAL’s index has offered a differentiated source of returns with lower volatility, giving it slightly better risk-adjusted returns.3
Against the traditional MSCI World Value Index, GVAL’s fundamentally weighted index outperformed by 2.3% p.a.4, driven predominantly by its smaller shortfalls when value underperforms.
Investment implications
For investors looking for a solution that focuses on business value rather than market capitalisation, fundamentally weighted indices offer an appealing alternative while also overcoming the shortfalls of some traditional value strategies.
As investors might expect from a value-oriented portfolio, GVAL’s index has a lower valuation than the MSCI World Index, with a P/E of 15.6x against 21.5x, and a higher trailing 12-month dividend yield, 2.3% against 1.5%.5 GVAL can be considered alongside, or in place of part of, a market capitalisation weighted global equity portfolio, or as a targeted value factor allocation within a broader portfolio.
For instance, value, momentum and quality are distinct investment factors with different sources of return. Because they can perform differently across market environments and have historically shown low or negative correlations, combining them may help diversify a portfolio’s sources of return and reduce reliance on any single investment style – as illustrated in our insight here.
With GVAL’s launch, Betashares now offers an ETF for each of the quality, value and momentum factors in both Australian and global markets.
For more information on GVAL visit the fund page here.
