The Acquirers Fund ETF Finds Great Fundamental Value by David Trainer

Summary

The significant underperformance of value strategies over the past 15 years has led many investors to ask: “Is value investing dead?"
The underperformance of major value index funds can be tied to their reliance on P/B and other unscrubbed traditional valuation metrics.
This new ETF avoids this problem by following a more comprehensive analytical process, which looks beyond traditional metrics and studies financial filings and footnotes to identify value.
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The significant underperformance of value strategies over the past 15 years has led many investors to ask: “Is Value Investing Dead?”

As we’ve argued, value investing isn’t dead, but one of the most popular value metrics – price to book (P/B) – is flawed and outdated. Changes in accounting rules, off-balance sheet liabilities, and the increased importance of intangible assets make P/B a poor measure of value.

The underperformance of major value index funds – such as the Russell 1000 Value ETF (IWD) – can be tied to their reliance on P/B and other unscrubbed traditional valuation metrics.

This new ETF avoids this problem by following a more comprehensive analytical process, which looks beyond traditional metrics and studies financial filings and footnotes, to identify value. The Acquirers Fund (ZIG) this week’s Long Idea.

Holdings Research Reveals Superior Stock Picking Methodology

According to Tobias Carlisle, author, investor, and founder and managing director of The Acquirers Funds:

“Acquirers Funds takes a holistic approach to valuation to understand the economic reality of each company. An important part of this process is a forensic-accounting diligence of the financial statements, particularly the notes and management’s discussion and analysis, to find information that a quantitative screen may miss.”

The Acquirers Fund’s methodology is based on The Acquirer’s Multiple, the valuation metric developed by Tobias Carlisle. The Acquirer’s Multiple is based on two key ratios:

Earnings before interest and taxes divided by enterprise value (EBIT/EV) Return on invested capital (ROIC) In addition to this screen, ZIG conducts a “forensic-accounting due diligence review” of potential holdings that includes footnotes analysis into all research.

This methodology helps the fund avoid “value traps” or stocks that look cheap based on metrics such as price to book, but are actually dangerous due to the poor quality of the underlying business.

We are not surprised that a methodology focused on footnotes and the MD&A identifies holdings that rate highly by our methodology. Figure 1 shows that ZIG allocates a significantly higher percentage of its long portfolio to Attractive-or-better rated stocks and a significantly lower percentage to Unattractive-or-worse rated stocks than its benchmark, the iShares Russell 3000 ETF (IWV).

Figure 1: ZIG Long Asset Allocation Compared to IWV

Sources: New Constructs, LLC and company filings Specifically, ZIG allocates 57% of its long portfolio to Attractive-or-better rated stocks compared to just 22% for IWV. On the flip side, ZIG allocates just 11% of its long portfolio to Unattractive-or-worse rated stocks compared to 32% for IWV.

ZIG’s long portfolio includes many stocks we’ve featured as Long Ideas: Cummins Inc. (CMI), Oshkosh Corp (OSK), Lear Corp (LEA), Insight Enterprises (NSIT), ManpowerGroup (MAN) and Southwest Airlines (LUV). These stocks make up almost 21% of ZIG’s long portfolio allocation.

ZIG’s Short Portfolio Is Even Better

ZIG runs a 130/30 long/short portfolio strategy, which means the fund allocates 130% of its AUM to long positions, offset by taking short positions worth 30% of its AUM. As a result, the fund remains net long the market, and its short positions effectively act as leverage to allow the fund to increase its exposure to its long portfolio.

Figure 2 shows ZIG allocated 87% of its short portfolio to Unattractive-or-worse rated stocks, and it does not short any Attractive-or-better rated stocks.

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