As the artificial intelligence hype and tech-led growth stock bull run begin to wane, investors are seeking out more stable and undervalued investment opportunities. Value ETFs, which focus on stocks that are trading below their intrinsic value, may offer a compelling alternative.
These exchange-traded funds often target companies with strong fundamentals, solid financial health, and attractive valuations, making them a potentially resilient choice in a changing market landscape.
Learn how these ETFs work within a value investing strategy, how to choose the best value funds for your portfolio, and the pros and cons of investing in them.
What Is a Value ETF?
A value ETF is a type of exchange-traded fund that invests in stocks or other securities that are considered undervalued or have a low price relative to their intrinsic value. Value ETFs typically focus on companies that have a strong financial position, stable earnings and a history of paying dividends.
The idea behind a value-based investment strategy is that the market sometimes undervalues stocks, and these undervalued stocks may provide more stable returns compared to growth stocks, which generally trade at a premium. Value investors use various metrics, such as price-to-earnings ratio (P/E ratio), price-to-book ratio (P/B ratio) and dividend yield to identify stocks that are undervalued.
As of Sept. 5, 2024, there were 127 value ETFs traded on U.S. markets with total assets under management of $522 billion. The average expense ratio for the category is 0.37%. The largest value ETF, as measured by assets under management, is the Vanguard Value ETF (VTV), with $124.3 billion in assets under management (AUM).
How Do Value ETFs Work?
Most value ETFs attempt to passively track an index of stocks or other securities that are considered undervalued or have a low price relative to their intrinsic value. Securities within the index may be defined by various stock valuation metrics, such as P/E ratio, P/B ratio and dividend yield to identify stocks that are undervalued.
While most value funds are passively managed, some value ETS are actively managed. Rather than attempt to mimic the returns of a benchmark like the Russell 1000 Index, an actively managed value ETF may attempt to outperform the benchmark.
Many value ETFs pay dividends, which may be paid quarterly, or at some other frequency, depending on the ETF. From the investor’s perspective, dividends may be received as income, or the investor may choose to have the dividends automatically buy more shares of the dividend ETF.
What Are the Types of Value ETFs?
There are several types of value ETFs that investors can consider, including broad-based value ETFs, sector-specific value ETFs, dividend ETFs and factor-based value ETFs:
Broad value ETFs: These ETFs invest in a broad range of undervalued stocks across various industries and sectors. These ETFs typically offer exposure to large cap, midcap and small cap stocks.
Sector-specific value ETFs: These ETFs invest in undervalued or dividend-paying stocks within a particular sector, such as energy, real estate or financials. Sector-specific ETFs may be appropriate for investors who want to target specific industries or sectors that they believe are undervalued or will provide income from dividends.
Dividend ETFs: These ETFs invest in stocks that have a history of paying dividends and are considered undervalued. Dividend ETFs may be appropriate for investors who are seeking income as well as long-term growth.
International value ETFs: These ETFs invest in undervalued stocks in markets outside of the United States. International value ETFs may provide investors with exposure to undervalued stocks in developed and emerging markets.
Factor-based value ETFs: These ETFs use a quantitative approach to identify undervalued stocks based on specific factors, such as low P/E ratio, low P/B ratio or high dividend yield. Factor-based value ETFs may be appropriate for investors who want a systematic approach to investing in undervalued stocks.
Investing in value ETFs has both advantages and disadvantages. For example, value ETFs can provide stable returns and a source of income through dividends. However, value ETFs still carry market risk and may also underperform growth stocks in some economic conditions.
Pros
Lower risk: Value stocks are often seen as less risky than growth stocks as they have a strong financial position, stable earnings and a history of paying dividends.
Source of income: Investors, such as retired investors looking for income-producing investments, may find value investing ETFs attractive for their combination of price stability and dividend income.
Diversification: Value ETFs provide investors with exposure to a diversified portfolio of undervalued stocks across various industries and sectors.
Low cost: Value ETFs typically have lower fees compared to actively managed mutual funds, making them a cost-effective investment option for investors.
Tax efficiency: ETFs are generally more tax efficient than mutual funds, as they have fewer capital gains distributions.
Cons
Underperformance: Value ETFs may underperform during periods of economic growth and when growth stocks are in favor.
Exposure to specific sectors: Sector-specific value investing ETFs may have a higher concentration of stocks in specific sectors, which could result in greater volatility and risk.
Market timing risk: Investing in value ETFs requires market timing to some extent, as the market may take some time to recognize the undervaluation and correct the stock price.
What to Look for in a Value ETF
Many of the selection criteria to look for in a value ETF, such low expense ratios, high assets under management and strong performance history, are the same for choosing the best ETFs in general. However, investors may also consider factors unique to value ETFs, such as the fund’s yield.
Investors should consider several factors when choosing a value ETF, including:
Market cap: Investors seeking more stable returns or income from dividends may prefer a large-cap value ETF, whereas investors seeking long-term growth or a compliment to a large-cap fund may choose a small- or mid-cap value ETF.
Yield: Income investors may evaluate a value ETF by its yield or its history of growing yields over time. Keep in mind that higher yields don’t necessarily translate to higher quality or higher returns. This is because some distressed companies may raise dividends to attract capital from dividend-hungry investors.
Expense ratio: Investors should look for value ETFs with low expense ratios, as higher fees can eat into returns over time.
Portfolio holdings: Investors should review the ETF's portfolio holdings to ensure they align with their investment objectives and risk tolerance. Investors should also consider the ETF's exposure to specific sectors or industries.
Performance history: Investors should review the ETF's performance history, including returns and volatility, to determine whether it aligns with their investment goals.
Fund size and liquidity: Investors should look for ETFs with sufficient assets under management and trading volume to ensure adequate liquidity.
Management style: Investors should consider whether the ETF is passively or actively managed. Passively managed ETFs typically have lower expense ratios, while actively managed ETFs may provide investors with a more targeted approach to investing in undervalued stocks.
Tax efficiency: Investors should consider the tax efficiency of the ETF, including its ability to minimize capital gains distributions.
Bottom Line on Value ETFs
Value ETFs can be a good investment choice for investors needing income from dividends or those that are attracted to greater price stability compared to growth ETFs. Like all investments, there are risks involved, and the value of a value ETF can fluctuate based on market conditions and other factors. It's important for investors to carefully consider their investment objectives and risk tolerance before investing in any ETF.
