EC Deep-Value ETF Report: Thursday, May 21

The coronavirus crisis has reordered expectations and valuations in global markets, but searching for the deepest discounts (based on negative return) delivers a familiar result: the commodities realm continues to offer the darkest shade of red.

The concept of value investing generally, thanks to weak results, has come under renewed scrutiny, again, in recent history. By some accounts, the notion of buying assets on the cheap and expecting to earn a relatively high risk premium for the effort has become null and void in the 21st century. Die-hard advocates of the value factor respond: Baloney! We’ve been here before and value’s dry spell will, once more, give way to its historical pattern of generating high absolute and relative returns to patient investors willing to tolerate short-term pain. By that reasoning, overweighting value, in one or more of its various guises, will continue to provide opportunities for portfolio design and asset allocation.

While we wait for Mr. Market to sort out this debate, let’s catch up with the numbers on the value front through a performance lens. But first, a quick refresher on the ranking system used below.

The metric of choice for “deep value” in this column is the 5-year return, which is based on an idea outlined in a paper by AQR Capital Management’s Cliff Asness and two co-authors:  “Value and Momentum Everywhere,” published in a 2013 issue of the Journal of Finance. There are numerous value metrics and so no one should confuse the 5-year-performance benchmark as the definitive measure of bargain-priced assets. But as a starting point in the process of identifying where the crowd’s expectations have stumbled, the 5-year change is a useful metric.

One advantage of using a 5-year performance measure: It can be applied over a broad set of assets, thereby dispensing a level playing field for evaluating value (or the lack thereof). Another plus: this metric is simple and therefore immune to estimation risk, which can complicate accounting-based value gauges, such as price-to-book and price-to-earnings measures. In short, the 5-year return is a handy tool as a first approximation for identifying ETFs that appear to be deeply discounted by the crowd — and thereby seem to offer relatively high expected returns via the value proposition for investing.

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Disclosure: None.

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