If You Don’t Like to Own Expensive Stuff in Your Portfolio, Invest in Value-based Factor Funds Instead. – Investment Moats

in my article You Should Diversify Away from Tech if You are a Long Term Investor Confident that A.I will Improving Productivity, I shared how I am getting more indirect questions about what actions they should take given where the market valuations are.

I think one common answer is: Avoid those companies that are expensive if they worry you?

That answer seems pretty useless for someone whose main strategy is to invest in capitalization-weighted index funds such as the IWDA [MSCI World], VWRA [FTSE All-World], CSPX [S&P 500].

You cannot not buy the expensive companies because you have no control over the funds. If a company becomes bigger and bigger and bigger, and occupies more, it becomes a larger proportion of the index fund.

If you go with that strategy, you benefit from the company becoming bigger and bigger and bigger, but the strategy is not one that has… a valuation layer, or it evaluates if the company becomes more expensive.

Now you might be able to understand why some would take the action of

1. Asking their adviser if it is ok to remain invested.
2. Should they stop dollar cost averaging into the fund itself given the valuation.

I translate that to: Deep down in your investment philosophy, valuation plays an important role.

But you are invested in a strategy (that is what cap weighted indexing is) that does not express your value oriented philosophy.

One of the reason why majority of Daedalus Income portfolio is in systematic active funds, rather than systematic passive funds (your IWDA, VWRA, CSPX) is because they express my investment philosophy better.

And valuation is an important component of my investment philosophy. I don’t like to buy expensive stuff and so I delegate that job to these funds who help me execute that.

I want to bring up one fund, which forms 8.5% of my portfolio, the Avantis Global Small Cap Value UCITS ETF (ticker: AVGS) as an example here. I talked about Avantis here, with some slight details about AVGS so you might want to read a little there to kind off understand that fund better.

I will explain AVGS simply as this:

1. Take the universe of global developed small cap, which is 60% US, 13% Japan, 4.8% UK, 3.8% Canada, 3.7% Australia.
2. Apply value and profitability rankings to them.
3. You will get a group of small companies that are really cheap, but still profitable because they eliminate the non-profitable ones, or those companies that have growth in investment assets.
4. You will get a group of companies that rank higher in terms of cash profitability and they tend to be not so cheap, but also not expensive.
5. This evaluation takes place on a very frequent basis and not during 2 or 4 periods of rebalancing if they follow some factor index.

By owning AVGS, I invest in a fund that I would have done this if I have the time and resources.

We can view AVGS with greater detail in Morningstar link here.

Year to date, AVGS is doing 13.3% in USD terms.

The average valuation currently is as follows:

1. Price to earnings: 10.5 times
2. Price to book: 1.1 times
3. Price to sales: 0.58 times
4. Price to cash flow: 4.7 times
5. Dividend yield: 2.8%

But AVGS can actually be seen as two parts: US and International and we can see their performance by looking at two of Avantis’ US funds that does the same small cap value strategies:

1. Avantis US Small Cap Value ETF (AVUV) – 2.44% YTD performance.
2. Avantis International Small Cap Value ETF (AVDV) – 41% YTD performance.

The US portion is probably closer to 66% at the start of the year and international portion to be 33%.

Based on the performance, you can see the US small cap to be dogshit and it is 66%, and the international is a great 41%.

Here is how they look in chart. AVDV in orange, AVUV in cyan, and the other line in between is AVGS:

But now that the international has gain 41%, is it wise to still hold on to it?

I have this mental question because I also own USSC which is the SPDR MSCI USA Small Cap Value-Weighted ETF and the goal eventually is to be all AVGS. But we are suppose to invest for the long term because the same that happen to international small cap value can happen to us small cap value.

If I blink I would missed it.

Now let us take at the average valuation of AVDV today:

The price earnings is 10 times compared to the benchmark index of 14 times. This despite AVDV going up 41% this year. You also detect the historical earnings growth of 271% (a large part due to the USD weaken) which is better than the index historical earnings growth off 131%. But what we are concern about is the long term earnings growth and you get a batch that is still projected to grow 9.6%.

Without me doing anything, the portfolio consistently rebalance to the stocks that can collectively give a higher long term expected returns, which is cheaper and more profitable companies.

So whether I buy today, or tomorrow, you end up owning companies that are more decent in valuation.

This jives well with my investment philosophy.

But it may not for you, if you have an aversion to cheap and profitable stuff.

Or how expensive something is, is not a big feature for you.

Either way, there are funds to help express your investment philosophy. Use the right one.

If you are in IWDA and that is a concern, maybe you want to consider IWVL or iShares Edge MSCI World Value Factor UCITS ETF. It did 34% this year, because developed international value did so well.

The average PE ratio is 14 times. IWDA is 26 times currently.

If you want to trade these stocks I mentioned, you can open an account with Interactive Brokers. Interactive Brokers is the leading low-cost and efficient broker I use and trust to invest & trade my holdings in Singapore, the United States, London Stock Exchange and Hong Kong Stock Exchange. They allow you to trade stocks, ETFs, options, futures, forex, bonds and funds worldwide from a single integrated account.

You can read more about my thoughts about Interactive Brokers in this Interactive Brokers Deep Dive Series, starting with how to create & fund your Interactive Brokers account easily.

Kyith is the Owner and Sole Writer behind Investment Moats. Readers tune in to Investment Moats to learn and build stronger, firmer wealth foundations, how to have a Passive investment strategy, know more about investing in REITs and the nuts and bolts of Active Investing.

Readers also follow Kyith to learn how to plan well for Financial Security and Financial Independence.

Kyith worked as an IT operations engineer from 2004 to 2019. Currently, he works as a Senior Solutions Specialist in Insurance Start-up Havend. All opinions on Investment Moats are his own and does not represent the views of Providend.

You can view Kyith’s current portfolio here, which uses his Free Google Stock Portfolio Tracker.

His investment broker of choice is Interactive Brokers, which allows him to invest in securities from different exchanges all over the world, at very low commission rates, without custodian fees, near spot currency rates.

You can read more about Kyith here.