Scott Kefer, CFA, senior portfolio manager at VictoryShares and Solutions, recently sat down to discuss the security selection screening process employed by the VictoryShares Free Cash Flow ETF (VFLO ). The ETF crossed one year since its inception over the summer and has $1 billion in AUM as of 10/3/24.
“Free cash flow is a powerful measure of the quality of a company,” explained Kefer. “It’s a sign of an efficient business, a well-managed business, and a solid business model.”
VFLO invests in quality companies with high free cash flow (FCF) yield¹ and tracks the Victory U.S. Large Cap Free Cash Flow Index (the Index).
VFLO: Quality & Holistic Free Cash Flow Screens
When investing in FCF, it’s important to look beyond just FCF generation. Companies may generate higher FCF by cutting operating expenses or capital expenditures. This also results in higher FCF without growing profits. The screens employed by the Index work to filter out such companies.
See also: Dispelling the Free Cash Flow CapEx Myth With VFLO
The Index methodology divides FCF by a company’s price. In the case of VictoryShares, enterprise value, a measurement of a company’s balance sheet, is used as the price. The use of enterprise value helps to screen out companies laden with debt. “You get quality in the numerator, you turn it into a valuation metric by putting it over price, and therefore free cash flow yield,” Kefer elaborated.
VictoryShares takes that one step further by calculating FCF as a holistic measurement that’s both backward- and forward-looking. This includes trailing 12-month FCF as well as forward 12-month FCF estimates.
“A lot of the industry is just simply looking at a company’s trailing free cash flow,” noted Kefer. “We think it’s important to also look at the expected free cash flow. It’s looking in the rearview mirror, but also looking through the windshield of what’s coming ahead.”
VFLO May Offer an Approach for Various Market Regimes
The starting universe includes approximately 1,000 stocks, and from there, the methodology screens for the 75 companies with the highest FCF yield first. It then applies a growth filter to further screen and remove the slowest-growing companies.
“We focus on the companies that have the quality (the free cash flow generation), the valuation (the free cash flow yield), and attractive growth profiles,” Kefer explained. “I think this is what comes together to help this portfolio in particular not only do well in a value regime — which is what you would typically expect from companies with high free cash flow yield — but also hold up in growth markets.”
Kefer went on to emphasize that the Index is not one of growth stocks but of quality, value stocks first and foremost. Of those stocks, the Index retains the fastest-growing companies, a “powerful, additive phase to the methodology” that leaves it attractively positioned beyond those environments conducive to value strategies.
“We find that to be both a very attractive portfolio from an opportunity standpoint, but it also gives it some defensive characteristics,” noted Kefer. “If markets were to correct more broadly, the ability of this portfolio to perform as well as it has, with no exposure to the Magnificent Seven, really creates a powerful component in the client portfolio.”
VFLO carries a net expense ratio of 0.39% (gross expense ratio of 0.66%).
Net expense ratios reflect the contractual waiver and/or reimbursement of management fees through at least Oct. 31, 2024.
For more news, information, and analysis, visit the Free Cash Flow Channel
VettaFi LLC (“VettaFi”) is the index provider for VFLO, for which it receives an index licensing fee. However, VFLO is not issued, sponsored, endorsed, or sold by VettaFi. VettaFi has no obligation or liability in connection with the issuance, administration, marketing, or trading of VFLO.
¹FCF yield is based on the weighted average of index constituents and is equal to the expected FCF divided by enterprise value. Expected FCF is the average of the trailing 12-month FCF and the next 12-month forward FCF. Enterprise value measures a company’s total value and is often used as a more comprehensive alternative to equity market capitalization.
Disclosure Information
Carefully consider a fund’s investment objectives, risks, charges, and expenses before investing. To obtain a prospectus or summary prospectus containing this and other important information, visit "http://www.vcm.com/prospectus":http://www.vcm.com/prospectus. Read it carefully before investing.
All investing involves risk, including the potential loss of principal. Please note that the Fund is a new ETF with a limited history. The Fund has the same risks as the underlying securities traded on the exchange throughout the day. Redemptions are limited, and commissions are often charged on each trade. ETFs may trade at a premium or discount to their net asset value. The Fund invests in securities included in, or representative of securities included in, the Index, reIndexess of their investment merits. The performance of the Fund may diverge from that of the Index. InIndexng in companies with high free cash flows could lead to underperformance when such investments are unpopular or during periods of industry disruptions.
The Fund could also be affected by company-specific factors that could jeopardize the generation of free cash flow. Derivatives may not work as intended and may result in losses. Large shareholders, including other funds advised by the Adviser, may own a substantial amount of the Fund’s shares. The actions of large shareholders, including large inflows or outflows, may adversely affect other shareholders, including potentially increasing capital gains. The value of your investment is also subject to geopolitical risks such as wars, terrorism, environmental disasters, and public health crises; the risk of technology malfunctions or disruptions; and the responses to such events by governments and/or individual companies.
Additional Information
The Victory U.S. Large Cap Free Cash Flow Index aims to select high quality companies from its starting universe by applying profitability screens. It then selects companies with the strongest free cash flow yield that exhibit higher growth. The Index is rebalanced and reconstituted quarterly. This Index calculates free cash flow yield by dividing expected free cash flow by enterprise value. Expected free cash flow is the average of trailing 12-month FCF and next 12-month forward free cash flow. Enterprise value (EV) measures a company’s total value, often used as a more comprehensive alternative to equity market capitalization.
Distributed by Foreside Fund Services, LLC (Foreside). Foreside is not affiliated with Victory Capital Management Inc. (VCM), the Fund’s advisor. Neither Foreside nor VCM are affiliated with VettaFi.
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