Traditional Value Index
A traditional value index is typically constructed by market cap weighting a group of stocks that rank highly for traditional "value factors" such as price earnings ratio, price-to-book value and dividend yield.
- Indexes typically consist of large diversified portfolios of stocks that are considered under-valued by the traditional measures of value.
- Portfolios should avoid growth bubbles such as the internet bubble of the late 1990's.
- Easy to construct relatively tax efficient ETFs and mutual funds.
- These indexes choose a subgroup of stocks from a large universe that meet certain value criteria. However, these subgroups of" stocks are often weighted by market cap. Weighting by market cap is inefficient and does not account for differences in cheapness between companies. In other cases, value indexes may weight by value characteristics but exclude companies that also have good growth characteristics and therefore not achieve an optimum value portfolio.
- Market cap weighting leads to a much more concentrated portfolio of stocks; therefore, results will be dominated by the largest stocks.
How to Calculate
- There are numerous ways to calculate a traditional value index depending on the index provider's view of the most important combination of "value factors". Indexes might use some or all of these or other factors: price-to-book ratio; price-to-earnings yield; price-to-sales; and, dividend yield. There are of course many other ways an index may calculate value for the purpose of constructing a value index.
Most traditional value indexes use a market cap weighting methodology to determine the size of each stock holding within the index.
- iShares Russell 1000 Value Index* – (ETF symbol: IWD)
The ETF employs an indexing investment approach to track the performance of the Russell 1000 Value Index, a subset of approximately 650 stocks from the Russell 1000 Index. These 650 stocks have the greatest value characteristics as defined by Russell, that may include low measures of price/book, price/earnings and price/sales. The ETF then weights this subgroup of 650 stocks by market capitalization.
- Vanguard Value* – (ETF symbol: VTV)
The ETF employs an indexing investment approach to track the performance of the MSCI® US Prime Market Value Index, a broadly diversified index predominantly made up of value stocks of large U.S. companies. The ETF attempts to replicate the target index by investing all, or substantially all, of its assets in the stocks that make up the Index, holding each stock in approximately the same proportion as its weighting in the Index.
- Schwab US Large Cap Value* – (ETF symbol: SCHV)
The ETF employs an indexing investment approach to track the performance of the large-cap value portion of the Dow Jones U.S. Total Stock Market IndexSM actually available to investors in the marketplace. The Dow Jones U.S. Large-Cap Value Total Stock Market IndexSM includes the components ranked 1-750 by full market capitalization and that are classified as "value" based on a number of factors. The index is a float-adjusted market capitalization weighted index. As of August 31, 2010, the index was composed of 310 stocks.
- Rydex S&P Pure Value* – (ETF symbol: RPV)
The ETF employs an indexing approach to track the performance of the S&P 500 Pure Value Index. The S&P 500 Pure Value Index is narrow in focus, containing only those S&P 500 companies with strong value characteristics as selected by S&P, but excludes companies with strong growth characteristics. The S&P 500 Pure Value Index includes companies with capitalizations ranging from approximately $1.1 billion to $154.5 billion. The components of the Index are weighted by a calculated value rather than market cap.
*Certain ETFs may have tax advantages over mutual funds. If managed well, most capital gain tax obligations are only recognized upon the sale of the ETF. Please note that ETFs with smaller market capitalizations are sometimes terminated by the sponsor with unexpected tax consequences. Therefore, it may be prudent to invest in ETFs with larger market capitalizations.