Value stocks are performing in-line with growth rivals and the broader market to start 2023, but as the year unfolds, less expensive names could separate themselves from the pack.
It’s a scenario plenty of market participants are betting, if it comes to life, would extend value’s run over growth. That could put a variety of exchange traded funds in the spotlight, including the Invesco RAFI Strategic US ETF (IUS ).
The $254.1 million IUS, which turns five years old in September, is a textbook example of index selection and methodology mattering in the ETF evaluation process. IUS follows the Invesco Strategic US Index, which is rooted in methodology pioneered by Research Affiliates (RAFI). The IUS benchmark assigns “a business-size score based on the equally-weighted average of sales, operating cash flow, total return of capital and book value over the prior five years or life of the security,” according to Invesco.
That represents a unique approach to value investing, one that clearly extends beyond focusing on low price-to-book and price-to-earnings ratios. While no methodology is perfect, the foundation upon which IUS rests could prove durable over the long haul.
“A byproduct of the RAFI Fundamental Index approach is a dynamic value tilt. By using fundamental measures of company size as a rebalancing anchor, the strategy tilts away from popular, trendy, and typically expensive companies toward unpopular companies that are trading at attractive valuations,” according to recent report by Research Affiliates.
IUS is relevant on another front. The ETF could be a different way for investors to combat inflation. In fact, historical data confirms value stocks often perform well during inflationary climates and as the economy shakes out of that scenario. That’s something to consider at a time when inflation is persistently high.
“The required rate of return (part of the denominator in a dividend discount model) captures both the equity risk premium and the risk-free rate. Following that intuition, changes in interest rates (the consequence of the Fed’s reacting to elevated inflation) can have knock-on effects for firm valuation depending on when those expected future cash flows are expected to arrive,” added RAFI.
As investors are learning, the Federal Reserve uses interest rate hikes to combat high inflation. That’s the historical playbook, and one the Fed isn’t shying away from. Of course, rising rates often weigh on rate-sensitive sectors, such as real estate and utilities. Fortunately for investors considering IUS, the Invesco ETF allocates just 1.91% of its roster to those sectors.
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