VFVA: A surprisingly decent active fund from a passive source

Did you know that Vanguard, the king of negativity, apparently has active money too? I know, I know – it can’t be real, can it? Well – it turns out they have an active fund that uses a quantitative, rules-based model to select securities, called America’s Vanguard Value Factor ETF European Training Foundation Involved (Bat: VFVA).

This actively managed ETF, which launched in 2018, uses a quantitative model to select U.S. stocks with a high probability of better-than-average returns because they trade at a lower price due to fundamental factors such as earnings, book value, sales and cash flow. In other words, the fund is betting on a value premium – a documented phenomenon where stocks with low price-to-fundamental ratios outperform their “higher growth” counterparts over long periods of time. Its prospectus describes a quantitative, rules-based model that is filtered through an investment universe consisting of large-, mid-cap and small-cap U.S. stocks.

I’m fascinated to look at where it comes from.

Look at the holding

This is a well-diversified portfolio consisting of approximately 600 names. No position constitutes more than 1.18% of the total portfolio.

This combination of holdings results in a price-to-earnings ratio for the fund of just 11.1 times, and a price-to-book of 1.3 times. This is an unambiguously value-leaning portfolio, just given the fundamentals. In turn, this has brought the media market capitalization more into the mid-range, at around $8 billion.

Sector configuration

I find the sector composition rather interesting, with technology making up only 4.9% of the portfolio. Financials, consumer discretionary, and industrials have the largest weights.

This sector allocation reflects VFVA’s value-oriented investment mandate. Sectors such as financials, industrials and energy tend to trade at discounted valuations compared to their growth counterparts. The tendency of the sector will likely cause VFVA to perform differently from the market index over time, especially when the environment tilts toward the growth side of the value/growth spectrum, as has been the case recently.

Peer comparison

Since this is active in screening, let’s compare the fund to Vanguard’s passive value fund, the Vanguard Value Index Fund ETF Shares (VTV). This fund tracks the CRSP US Large Cap Value Index, so it’s leaning more toward the side of large caps overall. You’d think this would mean VTV would outperform VFVA, but now that turns out to be the case. The two funds have been in sync with each other since 2021.

Pros and Cons

On the plus side, VFVA provides access to a widely diversified basket of undervalued U.S. stocks based on the fund’s quantitative model. By focusing on trading stocks at lower multiples compared to their fundamental value, VFVA aims to capitalize on the documented long-term value premium relative to the market as a whole.

But investors should also be aware of some of its disadvantages. As an actively managed fund, VFVA’s performance depends on the effectiveness of the quantitative model and the competence of the portfolio managers. Vanguard has a great track record as a company, but it’s not guaranteed that a VFVA strategy will always outperform market benchmarks or its peers.

Furthermore, the way VFVA tilts its value and the way it allocates its sectors is likely to lead to greater volatility and poor performance when growth stocks and specific sectors are strong market performers. Value strategies have a long history of extended periods of underperformance, and the VFVA sector’s concentrated exposure to financial and industrial companies is likely to exacerbate this cyclicality. Combine that with the fact that it has a number of small-cap stocks, and you may have a more volatile portfolio than you expect.

Conclusion

As a quantitative-style actively managed ETF that bets on the value premium by investing in undervalued US stocks, the Vanguard US Value Factor ETF isn’t bad, frankly. We all know that active has a hard time outperforming passive, but it has performed fairly well here in a cycle that has largely favored large-cap stocks. I think it’s worth considering if you’re looking for a different core customization.

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