The recent collapse of Silicon Valley Bank and Signature Bank has made investors nervous and has led to massive bank runs, the fall of many banking stocks, and increased market volatility. For investors worried about contagion infecting the banking sector and markets in general, the FCF US Quality ETF (TTAC ) has no exposure to banks, before or after the collapse of SVB.
According to FCF Advisors, a strategy that uses free cash flow as a primary stock selection driver tends to underweight banks for a few reasons. For one thing, banks have a unique set of financial statements that differ from those of other companies. banks generate revenue primarily by earning interest on loans and investments, and their expenses include interest paid on deposits and other borrowings.
As a result, banks do not have typical operating cash flows like other companies, making FCF calculations difficult.
Another reason is that capital expenditures are not the same for banks. They’re typically related to investments in technology, property, and equipment. However, banks do not typically have significant capital expenditures related to investments in fixed assets, as their primary assets are loans and investments.
Third, banks are subject to significant regulatory oversight, which affects their ability to generate and use cash. Banks are required to maintain minimum levels of capital and liquidity, which limits their ability to invest in certain activities or return cash to shareholders.
That’s why financial analysts typically use other measures, such as return on assets and return on equity, to evaluate a bank’s financial performance. FCF Advisors has found, however, that dividends and buybacks are empirically more important. In general, unlike other industries, the impact of fundamentals is much less than macro, capital structure, and regulatory environments, as demonstrated by the recent SVB collapse.
TTAC identifies companies with strong and sustainable profitability that provide core equity exposure with lower downside capture. The fund aims to outperform the Russell 3000 through a fundamentals-driven investment process that selects an average of 144 stocks based on free cash flow strength.
Its holdings are then weighted by a modified market-cap log transformation, allowing increased exposure to companies with the strongest proprietary free cash flow rankings. All the companies selected for inclusion in the actively managed ETF were chosen via FCF Advisors’ Free Cash Flow Quality Model (FCFQM), a multi-factor model featuring a combination of quality measures informed by the firm’s research. FCFQM relies on free cash flow rather than earnings.
“We believe a quantitative active solution is a go-to place in search of all-weather alpha that minimizes your market timing risks,” said Vince (Qijun) Chen, portfolio manager and director of research at FCF Advisors.
TTAC’s portfolio will also be rated with an ESG score, excluding companies with low ESG ratings. Firms with an extreme rise in share count and increase in leverage are excluded.
For more news, information, and analysis, visit the Free Cash Flow Channel