Avantis U.S. Small Cap Value Uses Flexibility to Its Advantage

Avantis U.S. Small Cap Value ETF AVUV shrewdly taps into value and profitability, a time-tested tandem of factors that complement one another well and should provide an edge. The management team consistently executes the strategy in a cost-efficient manner, warranting a People Pillar upgrade to Above Average from Average.

This fund sifts through the small-cap universe for stocks with the best combination of value and profitability characteristics, an attractive duo. Both factors have historically been tied to market-beating returns, and they tend to excel at different times. Threading the needle between both should keep the fund competitive in most market environments.

Once the fund whittles down its portfolio, it modifies stocks’ market-cap weights based on their value and profitability traits. Stronger companies receive a boost, while weaker firms see their portfolio share subside. This approach enhances factor exposures without neglecting the information stored inside stocks’ prices. Indeed, the portfolio trades at cheaper valuations than the small-value Morningstar Category benchmark (the Russell 2000 Value Index) and sported a better return on invested capital (a measure of profitability) than 97% of its small-value peers as of May 2023. All that comes with a bold but palatable 63% active share versus the Russell 2000 Value Index, giving the fund ample room to recoup its fee.

Market-cap weighting helps stymie turnover, and Avantis’ disciplined trading approach helps the same cause. The implementation team constantly weighs the cost-benefit of a trade’s expected added value to the portfolio against the requisite transaction cost, only acting when the scales tip in its favor. This flexibility is an advantage over similarly broad, well-diversified exchange-traded funds that rigidly track indexes.

A unique sector composition induces some risk. The fund avoids regulated utilities and real estate securities and takes a small stake in healthcare stocks. Energy and consumer discretionary companies fill the void; the fund’s stakes in those two sectors exceeded the Russell 2000 Value Index by 11 and 8 percentage points, respectively, as of May 2023. Trading defensive stocks for cyclical sector exposures invites volatility that may not be rewarded over the long term.