On the surface, value and momentum may seem like contradictory strategies. Value is about buying unloved securities, those that have been overlooked or shunned. Momentum seems like quite the opposite: aggressively chasing hot areas of the market with strong recent performance. But these concepts don’t conflict at all; they might even be two sides of the same coin.
Value is a long-term effect, while momentum is short term. Investors may initially under-react to new information, causing prices to adjust more slowly than they should, giving rise to momentum. However, as investors jump on the bandwagon, prices can overshoot fair value. This may lead to the long-term performance reversals associated with the value effect.
If done properly, combining value and momentum can help reduce exposure to value traps--stocks that look cheap but have deteriorating fundamentals. It might also reduce exposure to frothy areas of the market. This could be particularly helpful among small-cap stocks, which are more susceptible to mispricing than their larger brethren. Value and momentum strategies have tended to work the best among the smallest stocks--at least on paper.
VictoryShares USAA MSCI USA Small Cap Value Momentum ETF USVM is worth a look. This is a well-crafted, reasonably priced strategy that has a good chance to beat the broad MSCI USA SmallCap Index over the long term.
Strategy Overview The fund targets U.S. small-cap stocks with attractive value and momentum characteristics relative to their sector peers. It then weights its holdings so they each contribute an equal amount of estimated risk to the portfolio.
This focus gives the fund cleaner exposure to value and momentum than multifactor funds that target more factors. Researchers have known about these bedrock factors since the early 1990s, and they’ve paid off out-of-sample and outside academia, which breeds confidence they are likely to persist and not just the product of data mining. Despite its focus, the fund still offers good diversification because value tends to work well when momentum doesn’t and vice versa. Over the long term, both factors have good records, though the past decade has been unkind to value.
This portfolio doesn’t necessarily own the cheapest stocks, or those with the strongest momentum. Rather, it screens for those that look attractive across both metrics, allowing the entire portfolio to work together. This gives it stronger exposure to both factors than would be possible by combining separate value and momentum portfolios, as there tends to be little overlap between very cheap stocks and those showing strong momentum.
This strategy’s sector-relative approach to stock selection is distinctive. Morningstar research suggests this approach should improve the efficacy of value investing, though it may modestly hinder its ability to effectively capture momentum.
Value-driven sector tilts are persistent. For example, financial-services stocks almost always trade at lower average valuations than technology stocks, which isn’t surprising as the former tend to have more debt and tangible assets, as well as slower growth. However, these sector tilts are a source of active risk that historically hasn’t paid off nearly as well as picking the cheapest stocks within each sector.
This makes sense. Comparing valuations within each sector improves comparability, as sector peers tend to have more similar balance sheets, risks, and business models than firms in different sectors. So, differences in valuations within a sector should contain more information about expected returns than differences across sectors.
In contrast, price movements are directly comparable across sectors, and momentum-driven sector tilts are transient. This may explain why momentum sector bets have historically tended to pay off. Assessing momentum within each sector will likely cause the fund to own stocks with weaker momentum characteristics than it otherwise would. However, it should still offer decent exposure to momentum.
Nuts and Bolts This fund tracks the MSCI USA Small Cap Select Value Momentum Blend Index. This index uses standard metrics like price/book, price/forward earnings, and enterprise value/operating cash flow to assess value. Momentum is measured based on risk-adjusted performance over the past seven and 13 months (excluding the most recent one), which points the fund toward stocks with momentum that is more likely to persist.
This strategy sets a high bar for inclusion. It assigns composite sector-relative value and momentum scores to the stocks in the broad MSCI USA Small Cap Index and targets the top-ranking quarter. It applies a wide buffer around this threshold to mitigate unnecessary turnover.
Stocks that make the cut are weighted to target an equal risk contribution from each holding (based on their volatility over the past three years). So, more-volatile stocks receive lower weightings. This gives the portfolio a modest defensive bent and improves diversification. However, it can also introduce some sector tilts relative to the MSCI USA Index. For example, the fund currently has greater exposure to the real estate sector than that benchmark.
To mitigate transaction costs, the managers divide the portfolio into two halves and rebalance a different half each quarter. This approach increases capacity and reduces turnover. Capacity shouldn’t be an issue for a while, as this is a young fund with a small asset base.
Alternatives Invesco S&P SmallCap Value with Momentum ETF XSVM (0.39% expense ratio) may also be worth considering. However, this strategy is less balanced than USVM, focusing more on value than momentum. That's because it screens for value before momentum, so stocks won't make the cut unless they have strong value characteristics, and it weights it holdings by their value score, which deepens the value tilt. However, its nod to momentum should help reduce its exposure to stocks with deteriorating fundamentals.
IShares Edge MSCI Multifactor USA Small-Cap ETF SMLF (0.30% expense ratio) takes a broader approach to factor investing. It starts from the same selection universe as USVM, but it targets stocks with an attractive combination of quality, momentum, value, and small-size characteristics, while anchoring its sector weightings and risk to the broad small-cap market. This approach effectively diversifies risk and should deliver market-beating performance over the long term.
 Bryan, A., & McCullough, A. 2017. "The Impact of Industry Tilts on Factor Performance." https://www.morningstar.com/content/dam/marketing/shared/pdfs/Research/The_Impact_of_Industry_Tilts_on_Factor_Performance.pdf
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