In a recent article, the topic of small-cap value stocks’ laggard status relative to broader benchmarks was addressed. One of the key takeaways is that that domestic small-cap value names haven’t bad, but they’ve been trailing the Russell 2000 and S&P SmallCap 600 indexes by wide margins over the past few years.
That phenomenon is due in part to the recent resurgence of U. S. small-cap stocks being led by “junky” names, or those small companies that aren’t making any money. Advisors have seen this movie before. Small-cap rallies and rebounds often start with leadership from the asset class’s more speculative fare and if those resurgences prove durable, it’s often because market participants transition over to higher-quality smaller stocks, many of which reside in the value camp.
Such transitions take time and for impatient investors, there are avenues for tapping into high-flying small-cap value stocks. Get your investing passports ready and consider international small-cap value stocks, which thankfully are accessible via an array of exchange traded funds (ETFs).
One of the leaders in that clubhouse is the Avantis International Small-Cap Value ETF (NYSE: AVDV).
Assessing AVDV
Standing as a testament to validity of an active approach to ex-US small-caps, the Avantis ETF is on an impressive multi-year run of trouncing both domestic small-cap value rivals and broader measures of international small stocks.
(Chart Courtesy: Morningstar)
For those not familiar with AVDV, don’t worry about this being a young, small or both ETF. The fund debuted in September 2019 and is now home to $16. 6 billion in assets under management. It’s also a Morningstar medalist with a four-star rating from that research firm.
It’s nearly 1,600 holdings have a weighted average market capitalization of $2. 3 billion, so the fund’s managers aren’t “fudging” things by leaning into mid-caps. Said another way, they’re actually putting the size factor to work and doing so in investors’ favor.
Due to AVDV not being constrained by an index, the managers can overweight or underweight various sectors and regions and to the latter point, the Avantis ETF allocates 64% of its weight to just four countries – Japan, the U. K. , Canada and Australia. Just six other countries, all developed markets, are represented in the fund, but that geographic concentration and lack of exposure to more volatile emerging markets small-caps is serving investors well.
AVDV Emphasizes Profitability
As noted at the outset of this piece, junky small-caps are leading the way in the U. S. , but as AVDV’s multi-year success confirms, that’s not the case overseas. It’s actually the other way around and this ETF is capitalizing on that positive phenomenon.
“The managers target the top fourth of stocks with the most attractive combination of relatively low-price multiples and high profitability,” according to Morningstar. “Each stock receives a market-cap multiplier that scales its market-cap weighting. Cheaper stocks with higher profitability receive larger multipliers than those with the opposite characteristics. ”
Interestingly, a fair amount of AVDV member firms, though considered value stocks, are richly valued relative to the parent index, but those companies have the earnings to back up those “high” valuations, indicating investors aren’t paying up to get involved with this ETF.
“On average, the fund’s average price/book ratio tends to land somewhere near the MSCI ACWI ex USA SMID Value Index, while its average profitability tends to be noticeably higher,” concludes Morningstar.