Momentum ETFs could be set for a major rotation from growth to value prompting major portfolio construction questions for investors.
This comes amid the broader shift away from the primacy of growth stocks during the height of the coronavirus pandemic and towards cyclical equities since Pfizer published its vaccine results last November.
Over the last half year, a bounce-back in the ‘old economy’ and events such as the tech correction in March mean value names have cemented a period of advantage for the first time in almost seven years against a backdrop of low interest rates previously allowing growth to claim dominance well before COVID-19 arrived.
According to CFRA, this recent turnaround will be reflected in the rebalance of the $5bn iShares Edge MSCI USA Momentum Factor UCITS ETF (IUMF) in May, which bases its allocations on six and 12-month performance data through April.
The smart beta ETF returned 52% over the 12 months to April 23 – in line with the S&P 500. However, IUMF has struggled to keep pace so far this year rising 7.9% versus the US benchmark’s 12% gain. Having last rebalanced in November – when the rotation from growth to value was just materialising – the ETF’s underlying index is overweight tech, consumer discretionary and healthcare, with the three sectors claiming a net weighting of 74%.
Meanwhile, as oil prices soared in anticipation of increased manufacturing output and travel, IUMF had no energy holdings. And even as analysts highlighted financials’ potential for a drawn-out bull run, with P/E ratios below their 20-year average, the product only had a 1.5% weighting in finance stocks.
Flipping the script
Following the rebalance, CFRA has predicted some growth names to keep their footholds such as Apple and Tesla. With comparatively impressive gains of 91% over the past year and Q1 results offering another lift, Apple has returned 21% over the trailing six months. From a less orthodox basis, Tesla is expected to secure its place in IUMF with 403% returns over the last 12 months, and 80% growth in the last half-year, thanks to the addition of bitcoin to its portfolio.
In contrast, the positions of Amazon and Thermo Fisher Scientific look more doubtful. Over the past six months, the two firms returned 5.6% and 2.5%, respectively, with both up less than 50% year-on-year while claiming a 7.4% combined weighting in IUMF’s basket. Other companies to be cut include tech and consumer names such as Nike, Netflix and Costco, with CFRA saying those that benefitted from the stay-at-home economy will continue losing momentum during the recovery.
Taking up the space vacated by growth names will be financial stocks with CFRA expecting the industry to triple its footprint within IUMF’s basket. Among the candidates for inclusion could be Capital One and Wells Fargo which returned 89% and 109% over the trailing six months. Likewise, Invesco, Lincoln National Corp and SVB Financial could also be added while BlackRock and MSCI see their weightings increased.
Also set to plant its flag in IUMF’s index is the energy industry, with Devon Energy, EOG Resources, Occidential Petroleum and Valero Energy all up over 100% in the past six months, and therefore more than justified as momentum exposures. Currently making up none of IUMF’s basket, CFRA predicts IUMF will be overweight energy versus the S&P 500 after its rebalance.
Finally, CFRA said some travel and leisure names will be given their day in the sun after a tough first half of 2020. All doubling in value over the past 12 months, Carnival, Expedia and MGM Resorts could all be added to the ETF.
Late to the value party
Though IUMF’s anticipated swing to value comes half a year after the market rotation in this direction began in earnest, this trend will likely track the economic recovery through the rest of 2021 and potentially beyond. Amid fewer bankruptcies, dividend reinstatements and the economy yet to reopen, the cyclical stock bounceback likely has further to run.
“When one looks at value sectors like oils, banks, mining, real estate and airlines and so on they still look very cheap,” Peter Sleep, senior portfolio manager at 7IM, said.
Looking for value tilts and direct exposure, European investors have piled $1.6bn into the iShares Edge MSCI World Value Factor UCITS ETF (IWVF). Likewise, offering a cyclical tilt versus the vanilla equivalent, the Xtrackers S&P 500 Equal Weight UCITS ETF (XDEW) has claimed more than $2.8bn new assets this year.
A point to note on IUMF’s expected swing to value is the implications this will have for its environmental, social and governance (ESG) credentials.
Todd Rosenbluth, head of ETF and mutual fund research at CFRA and author of the report, said: “With the likely addition of energy companies and reduction in information technology stocks the future portfolio might appear less appealing to certain ESG minded investors.
“However all investors need to understand that the criteria is focused on price momentum alone and the holdings are fluid.”
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