Value stocks have disappointed over the past decade, significantly lagging their growth counterparts and testing even the most patient investors. Such bouts of underperformance are a real risk for any strategy that deviates from the market, and those who are not comfortable with it should stick with broad market index funds. However, value investing is still a reasonable strategy that should reward investors over the long term.
While it's difficult to predict when large-value stocks will do well relative to the broader market, the U.S.-listed 
Vanguard Value ETF (VTV) is one of the best options for exposure to this area of the market. It offers a diversified, market-cap-weighted portfolio, which promotes low turnover and is representative of its actively managed peers' opportunity set.
The fund tracks the CRSP U.S. Large Cap Value Index, which targets stocks representing the cheaper and slower-growing half of the U.S. large-cap market and weights them by market capitalization. This weighting approach tilts the portfolio toward the largest value stocks, giving the fund a larger-cap orientation than most of its peers. The biggest stocks are not necessarily the cheapest. Market-cap weighting can even reduce the fund's exposure to stocks as they become cheaper, as this typically accompanies a decline in market cap. That said, the fund tends to have a similar value orientation to the average fund in the large-cap value category in the United States.
Large-value stocks tend to be mature businesses that are often trading at low valuations for good reason, including slow expected growth and, in some cases, high business risk. The portfolio's largest holdings include market giants such as Exxon Mobil (XOM), Microsoft (MSFT) and Johnson & Johnson (JNJ). These large-cap stocks likely offer lower return potential than smaller-value stocks, but they also tend to be less risky.
While it casts a wide net and applies generous buffer rules to limit turnover, the fund has less overlap with its growth counterpart than rival value and growth funds based on the Russell 1000 Index and the S&P 500. To further limit transaction costs, the fund's index moved to a five-day rebalancing schedule in September 2017. This way, the fund shouldn't move prices as much as it previously did when it concentrated all the trades on one day.
The fund's greatest advantage is its low 0.05% fee. This cost advantage helped the fund outpace the large-value category average by 126 basis points annually during the 10-year period through April 2018, with comparable volatility. Also, the managers generate extra revenue for the fund through securities lending, which helps offset its expenses. As a result, the fund lagged its benchmark by only 3 basis points over the past three years.
Fundamental view
Large-cap stocks seldom trade at low valuations without good reason. The low valuations of the fund's holdings tend to reflect lower expected growth, profitability, or higher risk (business or financial) than their pricier counterparts. Directionally, the market gets valuations right, so the fund's holdings aren't necessarily bargains. But they could become undervalued, if investors extrapolate past growth--or lack thereof--too far into the future. That said, large-cap stocks are less likely to be mispriced than small-cap stocks, as they are more widely followed.
Despite their less-attractive business prospects, value stocks have historically outpaced their growth counterparts over the long term in most markets studied. This effect has historically been the smallest among the largest stocks, probably because they are less likely to be mispriced. Mispricing may help explain the success of value investing, but that's not the only explanation. Investors may rationally demand higher expected returns for holding value stocks as compensation for risk.
Value investing doesn't always pay off. For example, this fund lagged Vanguard Growth ETF (VUG) by more than 2 percentage points annualized over the past decade. Part of that owes to sector biases associated with the value investment style. Some sectors, like financial services and utilities, persistently trade at lower valuations than others, like technology. These persistent sector biases are a source of active risk, which historically have not been well-compensated. Over the past decade, the fund's underweighting of the strong-performing consumer cyclical and technology sectors and overweighting of the weak-performing energy sector hurt its performance.
This broad, market-cap-weighted portfolio effectively diversifies risk. It includes more than 300 holdings, the top 10 of which account for just over a fourth of the portfolio. While they have low expected growth rates, most of these firms are profitable. Market-cap weighting pulls the fund toward the largest value stocks, which are not necessarily the cheapest. That said, the fund's value orientation is usually similar to the category average. Market-cap weighting reflects the market's view about the relative value of each holdings and promotes low turnover. While the portfolio includes mid-cap stocks, it has a larger market-cap orientation than most of its peers.
Most of the fund's sector weightings are similar to the category norm, though it has greater exposure to the technology sector and less exposure to consumer cyclical stocks. Like most of its peers, the fund tilts toward the financial-services, utilities and energy sectors. The fund does not constrain its sector weightings or make any sector-relative valuation adjustments.
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