Advisors flock to ETF that turns traditional value investing on its head

All it took for a relative newcomer to the ETF space was a small tweak to traditional value investing to create one of the hottest funds on the market.

While value investing advocates remain obsessed with price-to-book value formulas, Pacer ETFs focused on free cash flow metrics and tasked Russell Investments with highlighting the 100 Russell 1000 companies with the highest free cash flow returns.

The Pacer US Cash Cows (COWZ) ETF was launched in December 2016 and gradually grew to several hundred million until two years ago the economic environment, including rising interest rates and high inflation, set the stage for value investing.

COWZ has smashed the growth-oriented S&P 500 over the past two years, gaining 42.6% in 2021 when the S&P rose 28.7% and 20 basis points last year when the S&P fell 18.1%.

ETF assets have increased to nearly $13 billion.

“The origin of the strategy is basically that we had this idea of ​​how the stock market works today, valuations are basically based on the company’s intangible assets, and the traditional value approach to investing is low price to book value,” Sean said. O’Hara, President of Pacer ETF.

The problem with this traditional valuation modeling, O’Hara explained, is that it overlooks the value of intangible assets, especially in companies like Uber and AirBnb, which have very few tangible assets.

“The free cash flow income a company generates is divided by its enterprise value, and enterprise value is market capitalization plus debt minus cash,” he said. “It’s really simple. But no one thought of this strategy because structure and hierarchy have been there all along and there are so many ingrained uses.”

Basically, there is nothing new in focusing on free cash flow, but using it as a primary indicator is unique.

In addition to its outstanding performance against the S&P 500, COWZ is running away from the broader Russell 1000 Index. In just over six years since its launch, COWZ has delivered an annual return of 14.3%, comparable to the Russell 1000’s 8% annual return. for the same period.

With $23 billion, Pacer is in 16th place.th the largest ETF provider in the country and enjoying unique success for a company founded just seven years ago.

Todd Rosenbluth, director of research at VettaFi, believes COWZ has a clear strategy in place that is well suited to the current environment.

“COWZ is a high quality cash flow strategy and is in demand when revenues and market volatility rise,” he said. “But small firm funds rarely break out that way.”

The $13 billion COWZ represents more than half of Pacer’s total assets, but the company offers seven other free cash flow ETFs. And, according to ETF.com’s Sumit Roy, Paser will likely be riding this horse for a while.

O’Hara acknowledges that it’s not just the unique scoring metric and recent results that have attracted so much money to COWZ over the past two years.

“We have 79 external wholesalers targeting wire services, larger RIAs, smaller RIAs, insurance companies and banks, and we have a presence on all major platforms,” he said. “The main reason we have been successful is because we spend time with financial advisors and a little bit of clarification is needed to understand what COWZ is. You have to understand cash flow returns and why it works under certain conditions.”

COWZ is up 5% this year, broadly in line with the S&P 500. O’Hara said the value-driven strategy must remain competitive until the market enters a new phase of strong growth.

“The data we have will lead us to believe that he will succeed at the bottom, because the market will have to go through a capitulation phase,” he said. “During the massive growth phase, we will probably lag behind growth, but we will do well compared to traditional value.”

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