KFAC – Background & Rationale on Recent ETF Trades

Nicholas Coppola, CFA

June 4, 2020

 

As you may have seen in recent trade confirmations, we have replaced the Invesco SmallCap Low Volatility ETF (XSLV) with the iShares Core S&P Small-Cap ETF (IJR).  At a high-level, we think that IJR represents an inexpensive way to gain access to US Small Cap stocks, and over the long-term, we like its greater sector diversity.  Note that XSLV, because of its focus on the low volatility factor, has historically been significantly overweight financials and real estate and significantly underweight IT and healthcare, which since inception of the fund has been a detractor from performance.  And as we compare financial metrics for the two funds based on the weighted average of their holdings, our proprietary scoring system suggests that IJR appears more attractive, particularly in regard to valuation.  

While our investment philosophy continues to lean more heavily on expectations for long-term fundamentals and the intrinsic value of investments, we do think the current environment historically sets up favorably for small caps, which helps support our rationale for the trade.  As we look at prior downturns, after the S&P 500 sees a significant drop, and after periods of high volatility, small caps tend to outperform.  Consistent with this, Ned Davis Research (NDR) recently upgraded small caps to ‘overweight’ based on a number of technical indicators, as well as their expectations for a severe but short recession.  NDR also pointed to ‘mean reversion’ potential, after large caps have significantly outperformed small caps since the summer of 2018.  As this relates to our trade, in an environment where small caps move meaningfully higher, we think a market cap-weighted fund stands to benefit more than a low volatility fund.   

As always, please let us know if you have any questions regarding recent trades or your broader portfolio.  We thank you for your continued trust and hope that you are well.

Sincerely,

Nicholas Coppola, CFA
Senior Portfolio Manager

 

Nicholas Coppola, is a Senior Portfolio Manager at Kays Financial Advisory Corporation. He can be reached at (770) 951-9001 or at ncoppola@scottkays.com.

 

This report and Mr. Coppola’s comments are provided as a general market overview and should not be considered investment or tax advice or predictive of any future market performance. Any security mentioned in this report may not be suitable for all investors. No investment mentioned in this newsletter constitutes a recommendation to buy, sell or hold a particular investment. Such recommendations can only be made on an individual basis after an assessment of an individual investor’s risk tolerance and personal circumstances. Past performance of any investment mentioned is not a guarantee of future performance. Statements regarding the investment concerns and merits of any investment and fair market value computations are strictly the opinion of Kays Financial Advisory Corporation. Employees of KFAC and KFAC clients may have positions and effect transactions in the securities of the issuers mentioned here in.