A Durable Value Strategy In This ETF

As was widely documented throughout 2017, value stocks lagged their growth and momentum counterparts. The S&P 500 Value Index gained just 15.1 percent, trailing the S&P 500 by a wide margin and the S&P 500 Growth Index by over 1,100 basis points.

Not all exchange traded funds dedicated to value stocks floundered last year. The WisdomTree U.S. Earnings 500 Fund EPS was a notable exception to the 2017 value malaise, gaining 22.6 percent to outperform an array of more traditional value funds.

EPS, which turns 11 in February, follows the WisdomTree U.S. Earnings 500 Index. That benchmark is weighted by earnings, ensuring member firms are profitable. The issuers focuses on core earnings, which “is a standardized calculation of earnings developed by Standard & Poors designed to include expenses, incomes and activities that reflect the actual profitability of an enterprise's ongoing operations,” according to WisdomTree. 

A Value Tilt

EPS has a value tilt, but the ETF was able to outperform the broader market last year while the value factor scuffled. The manner in which EPS is rebalanced is one of the reasons why the fund offers the potential for outperformance.

“WisdomTree conducts an annual rebalance of its earnings-weighted family every December,” WisdomTree said in a recent note. “This once-a-year process incorporates a rules-based discipline to sell what is becoming more expensive on a price-to-earnings basis and buy what is becoming cheaper on that basis. This, by definition, incorporates an element of anti-momentum trading and valuation tilting to lower-priced segments of the market. With this headwind of value lagging growth considerably, you would think this was a difficult performance environment for the WisdomTree U.S. Earnings 500 Index.” 

At the end of December, EPS featured exposure to 25 industry groups, with technology accounting for almost 23 percent of the ETF's weight. Financial services, widely cited as a value sector, account for 20 percent of the ETF's roster.

Believing In Value

History has shown that value stocks outperform over the long-term, but that the time to embrace the value factor is when legitimate value is being offered. Time will tell, but past precedent could bode well for a 2018 value rebound.

“WisdomTree believes valuation-oriented rebalancing becomes increasingly important as market multiples rise,” said WisdomTree. “This defines the market environment we’ve had over the last seven or eight years. If you are concerned with the S&P 500 P/E ratio approaching 23x, a post-rebalance P/E ratio of the WisdomTree U.S. Earnings 500 Index has a price-to-earnings ratio of 18x to 19x earnings before any tax-related impacts. This is a reasonable price for a broad-based strategy of U.S. large caps, in our view.”

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