Market Overview

An ETF To Help Avoid Value Traps

An ETF To Help Avoid Value Traps

Value stocks often tempt investors because of, well, perceived value, but by the time many investors awaken to the advantages of the value factor, some of these stocks become expensive. Perhaps worse yet, some are legitimate value traps.

A new exchange-traded fund takes a unique, smart beta approach to helping investors tap the value factor while potentially dodging value traps. The PowerShares S&P 500 Value With Momentum Portfolio (BATS: SPVM) debuted in early April.

Set Your Sights On SPVM

SPVM tracks the S&P 500 High Momentum Value Index, which “tracks the performance of stocks in the S&P 500 Index that have the highest value and momentum score. Constituents are selected through a two-step process: first, the 200 stocks with the highest value scores; second, 100 securities with the highest positive momentum scores,” according to PowerShares, the fourth-largest U.S. ETF issuer.

SPVM has one of the hallmarks of traditional value ETFs, that being a large weight to financial services stocks. Financials are by far the new ETF's largest sector weight at over 32 percent. Utilities, SPVM's second-largest sector weight and a group that is often expensive on valuation, account for almost 20 percent of the fund's roster.

Evaluating The Value Claim

“While value can be an appealing investment strategy, identifying value opportunities is not as easy as it might appear,” said PowerShares in a recent note. “One of the drawbacks of value investing is the so-called 'value trap.' A value trap occurs when a stock appears cheap, but is trading at low multiples due to underlying problems with the stock’s issuer. In other words, the stock is cheap for a reason and could trade even lower in the future. Changing industry conditions, secular shifts in technology, and management miscalculations can lead to value traps. Further, some valuation measures may be backward-looking when the market is pricing the future.”

SPVM's efforts to avoid value traps is seen with its scant weight to the energy sector, a sector that like financials, figures prominently in many traditional value funds. SPVM currently allocates barely more than 0.6 percent of its weight to energy stocks, making the group the ETF's smallest sector weight.

Data suggest SPVM's current avoidance of the energy sector could be an advantage for investors.

“On a price-to-book basis, the spread between the S&P 500 Index and the S&P 500 Energy Index went from 0.10 in April 2011 to -1.04 by the end of January 2015,” said PowerShares. “Despite these low valuations, the price of the S&P 500 Energy Index retreated another 24 percent over the ensuing 12 months. So, even though the energy sector had become more attractively priced, energy prices continued to drop — again highlighting the difficulty in discerning value. By contrast, the S&P 500 Index declined only 3.1 percent across this same period.”

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