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A Strong Large-Value ETF

This is one of the best choices for exposure to U.S. large-value stocks.

Securities In This Article
Microsoft Corp
(MSFT)
DFA US Large Cap Value I
(DFLVX)
Schwab US Large-Cap Value ETF™
(SCHV)
Schwab Fundamental US Large Company ETF
(FNDX)
iShares S&P 500 Value ETF
(IVE)

Value stocks have disappointed over the past decade, significantly lagging their growth counterparts and testing even the most patient investors. Such bouts of underperformance are a real risk for any strategy that deviates from the market, and those who are not comfortable with it should stick with broad market index funds. However, value investing is still a reasonable strategy that should reward investors over the long term.

While it’s difficult to predict when large-value stocks will do well relative to the broader market,

Vanguard Value ETF

VTV is one of the best options for exposure to this area of the market. It offers a diversified, market-cap-weighted portfolio, which promotes low turnover and is representative of its actively managed peers' opportunity set. The fund's considerable cost advantage further supports a Morningstar Analyst Rating of Silver.

The fund tracks the CRSP U.S. Large Cap Value Index, which targets stocks representing the cheaper and slower-growing half of the U.S. large-cap market and weights them by market cap. This weighting approach tilts the portfolio toward the largest value stocks, giving the fund a larger-cap orientation than most of its peers. The biggest stocks are not necessarily the cheapest. Market-cap weighting can even reduce the fund’s exposure to stocks as they become cheaper, as this typically accompanies a decline in market cap. That said, the fund tends to have a similar value orientation to the large-cap value Morningstar Category average.

Large-value stocks tend to be mature businesses that are often trading at low valuations for good reason, including slow expected growth and, in some cases, high business risk. The portfolio's largest holdings include market giants such as

While it casts a wide net and applies generous buffer rules to limit turnover, the fund has less overlap with its growth counterpart than rival value and growth funds based on the Russell 1000 Index and S&P 500. To further limit transaction costs, the fund’s index moved to a five-day rebalancing schedule in September 2017. This way, the fund shouldn’t move prices as much as it previously did when it concentrated all the trades on one day.

The fund’s greatest advantage is its low 0.05% fee. This cost advantage helped the fund outpace the large-value category average by 126 basis points annually during the trailing 10 years through April 2018, with comparable volatility.

Fundamental View Large-cap stocks seldom trade at low valuations without good reason. The low valuations of the fund's holdings tend to reflect lower expected growth, profitability, or higher risk (business or financial) than their pricier counterparts. Directionally, the market gets valuations right, so the fund's holdings aren't necessarily bargains. But they could become undervalued, if investors extrapolate past growth--or lack thereof--too far into the future. That said, large-cap stocks are less likely to be mispriced than small-cap stocks, as they are more widely followed.

Despite their less-attractive business prospects, value stocks have historically outpaced their growth counterparts over the long term in most markets studied. This effect has historically been the smallest among the largest stocks, probably because they are less likely to be mispriced. Mispricing may help explain the success of value investing, but that’s not the only explanation. Investors may rationally demand higher expected returns for holding value stocks as compensation for risk.

Value investing doesn’t always pay off. For example, this fund lagged

This broad, market-cap-weighted portfolio effectively diversifies risk. It includes more than 300 holdings, the top 10 of which account for just over a fourth of the portfolio. While they have low expected growth rates, most of these firms are profitable. Market-cap weighting pulls the fund toward the largest value stocks, which are not necessarily the cheapest. That said, the fund’s value orientation is usually similar to the category average. Market-cap weighting reflects the market’s view about the relative value of each holdings and promotes low turnover. While the portfolio includes mid-cap stocks, it has a larger market-cap orientation than most of its peers.

Most of the fund's sector weightings are similar to the category norm, though it has greater exposure to the technology sector and less exposure to consumer cyclical stocks. Like most of its peers, the fund tilts toward the financial-services, utilities, and energy sectors. The fund does not constrain its sector weightings or make any sector-relative valuation adjustments.

Portfolio Construction The fund employs full replication to track the CRSP U.S. Large Cap Value Index. This broad, market-cap-weighted index diversifies risk, promotes low turnover, and accurately reflects the composition of its target market segment, supporting a Positive Process Pillar rating.

CRSP defines large-cap stocks as those representing the largest 85th percentile of the U.S. stock market. It uses several metrics to assign composite value and growth scores to each stock. The growth metrics include projected short- and long-term earnings-per-share growth, three-year historical earnings and sales-per-share growth, current investment/assets, and return on assets. CRSP evaluates value on book/price, forward and trailing earnings/price, dividend yield, and sales/price. It fully allocates stocks with the strongest value characteristics to the value index until it represents half the assets in the large-cap market.

CRSP keeps 100% of each stock in its respective style index until it passes through a buffer zone. At that point, CRSP moves only 50% of the stock from one style index to the other, spreading the trades out over five days. If the stock stays on the opposite side of the buffer zone at the following quarterly review, CRSP will transfer the remaining half. This approach mitigates turnover where it does not significantly affect the fund's style characteristics.

Fees Vanguard charges a razor-thin 0.05% expense ratio for this offering, making it one of the cheapest funds in the category. Therefore, the fund earns a Positive Price Pillar rating. The managers generate ancillary revenue for the fund through securities lending, which helps offset some of the fund's expenses. As a result, the fund lagged its benchmark by only 3 basis points over the trailing three years through April 2018.

Alternatives

Investors concerned about unintended sector bets that traditional value funds could introduce might consider Bronze-rated

Bronze-rated

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About the Author

Alex Bryan

Director of Product Management, Equity Indexes
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Alex Bryan, CFA, is director of product management for equity indexes at Morningstar.

Before assuming his current role in 2016, Bryan spent four years as a manager analyst covering equity strategies. Previously, he was a project manager and senior data analyst in Morningstar's data department. He joined Morningstar in 2008 as an inside sales consultant for Morningstar Office.

Bryan holds a bachelor's degree in economics and finance from Washington University in St. Louis, where he graduated magna cum laude, and a master's degree in business administration, with high honors, from the University of Chicago Booth School of Business. He also holds the Chartered Financial Analyst® designation. In 2016, Bryan was named a Rising Star at the 23rd Annual Mutual Fund Industry Awards.

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