RFV ETF: High risk, high return strategy for pure value investors (NYSEARCA:RFV)

Investment thesis

This article discusses the strengths and weaknesses of the Invesco S&P MidCap 400 Pure Value ETF (NYSEARCA:RFV), a highly unbalanced product that is unlikely to deliver consistent returns every year, but still works as advertised. A look back at the performance so far shows that RFV becomes more attractive as you lengthen your holding period, and as long as you can tolerate the volatility, RFV has a good chance of being a long-term winner. I wish it performed better on other fundamental metrics, but I’m confident it will appeal to certain readers and look forward to describing his approach in more detail below.

Overview of RFV

Strategy discussion

RFV tracks the S&P MidCap 400 Pure Value Index, which was launched on December 16, 2005, three months before the ETF. The selection process begins with the S&P MidCap 400, whose components are about one tenth the size of S&P 500 index constituents on average. From there, the index provider assigns each security a growth and value score based on six factors:

The Pure Value Index includes stocks that perform best on the three value factors: book value to price, earnings to price and sales to price. However, it is also important to consider that there can be no overlap with the Pure Growth Index. Therefore, the stocks selected by RFV must also perform relatively poorly on three-year earnings per share growth, three-year sales per share growth and one-year price momentum. This becomes clear when analyzing the fundamentals, but let’s first look at RFV’s historical performance against four benchmarks.

Performance analysis

The four ETFs I chose as benchmarks are the following:

1. Invesco S&P MidCap Value with Momentum ETF (XMVM)
2. WisdomTree US MidCap Dividend Fund ETF (DON)
3. iShares S&P Mid-Cap 400 Value ETF (IJJ)
4. iShares Morningstar Mid-Cap Value ETF (IMCV)

RFV has outperformed them all over the past decade, delivering a total return of 141.19% (9.20% annualized), 13% better than XMVM.

Despite these strong returns, RFV’s risk-adjusted returns (Sharpe and Sortino ratios) are not outstanding, giving us an initial indication that it is a risky product. The maximum decline of 44.85% in the table above occurred from September 2018 to March 2020 and was about 9% worse than these peers. Looking further back to the Great Financial Crisis, RFV declined 63.58% and took two years and an outstanding gain of 59.74% in 2009 to recover.

Because of these large swings, timing is especially important for short-term investors. It is too difficult to predict strong bull and bear markets, so in this section I will just point out that the RFV can be quite unpredictable. I will explain the reasons for this shortly in the fundamental analysis section.

RFV analysis

Sector exposures and top ten holdings

The table below shows the differences in sector exposure between RFV, XMVM, DON, IJJ and IMCV. RFV is overweight in the consumer discretionary sector at 26.19%, but appears to be fairly well diversified at the sector level. Technology is also slightly overweight compared to DON, IJJ and IMCV.

RFV basics by sub-sector

The table below shows selected fundamental metrics for RFV’s top 25 sub-industries, which together make up 74.60% of the portfolio. This level of concentration is significantly higher than DON, IJJ and IMCV. Therefore, I think the main reason RFV is so unpredictable is that it is not well diversified. Investors take the risk that these sub-industries will temporarily fall out of favor, but hope that their patience will be rewarded in the long run.

Here are some additional observations to consider:

1. RFV’s five-year beta is currently 1.46, the highest in this peer group and among all mid-cap ETFs of all styles (value, blend, growth). This value may surprise value investors who are used to value ETFs that offer some downside protection. It’s important to remember that you won’t get that if you go the “pure value” route, and this trait isn’t limited to mid-caps. The Invesco Russell Top 200 Pure Value ETF (SPVM), the Invesco S&P 500 Pure Value ETF (RDB) and the Invesco S&P 500 Enhanced Value ETF (SPVU) have five-year betas of 86/97, 87/97 and 90/97 in the large-cap value category. The Invesco S&P SmallCap 600 Pure Value ETF (RZV) ranks 30th/34th among small-cap value ETFs. This obviously suggests that they are all quite volatile and can produce huge gains and losses.

2. I mentioned earlier that RFV would likely not deliver good growth due to its selection process. However, I am disappointed that the estimated EPS growth rate is negative. On a sector-adjusted basis using Seeking Alpha Factor Grades, RFV’s Growth Score of 4.22/10 is the lowest among all mid-cap ETFs and ranks 794th/836th overall. Moreover, its Earnings Score of 5.87/10 is also ranked last among all mid-cap ETFs (776th/836th overall). So the conclusion is that a lot can go wrong with the current setup. I don’t know how RFV has performed on these metrics in past years, but these red flags prevent me from giving RFV a Buy recommendation.

3. RFV trades at 15.18 times forward earnings using the simple weighted average method, or 11.48 times using the harmonic weighted average method. On a sector-adjusted basis, its Value Score of 6.99/10 ranks 1st among all mid-cap ETFs and 16th/836 overall, hence my claim that RFV performs as advertised. The only caveat is that its EPS Revision Score of 5.53/10 is the second worst in the category, which shows that its constituents are cheaply valued because Wall Street consensus earnings estimates are weak. That’s often the case with value stocks, but for some investors that might be too extreme, so in addition to the ability to tolerate volatility, you should also adopt a contrarian mindset.

Investment recommendation

RFV is not for me because it performs so poorly on growth, quality, and earnings revisions. However, the pure value strategy has performed well over the long term, especially because it has produced exceptional returns in some time periods that are difficult to predict in advance. So I want to keep this ETF open. It could be a good choice if your risk tolerance is high and you’re not the type of person who gets too put off by short-term underperformance. So I’ve assigned RFV a neutral “Hold” rating and look forward to re-evaluating it later this year. Thanks for reading.