Deep value in the S&P 500 Index

This fund offers a heavy dose of value, but it may overweight companies with deteriorating fundamentals.

Alex Bryan 9 May, 2014 | 11:25PM

Most value index funds target the cheaper half of the market, which tends to sweep in a large helping of blend stocks that dilute their value tilts. In contrast, Guggenheim S&P 500 Pure Value RPV targets the cheapest third of the S&P 500 Index and weights its holdings by the strength of their value characteristics. This style purity allows investors to add a value tilt to a diversified portfolio with a smaller investment in this fund than its peers would require.

This approach has generated attractive returns. Over the 10-year period through April 2014, the fund's benchmark -- the S&P 500 Pure Value Index -- outpaced the market-cap-weighted S&P 500 Value Index, which tracks the cheaper half of the S&P 500 Index, by 4.6% annualized. However, part of this performance gap may be due to differences in market capitalization. Because the pure value index doesn't weight its holdings by market cap, it tends to have a smaller-cap tilt. For instance, the average market cap of its holdings (US$19.6 billion) is currently only a fraction of the corresponding figure for the S&P 500 Value Index (US$70.1 billion). During the past decade, the S&P 500 Pure Value Index outpaced the Russell Midcap Value Index by a more modest, but still respectable, 1.2% annualized.

Value stocks have historically outperformed their growth counterparts in nearly every market studied over long time horizons. Because of its deeper value tilt, RPV may be able to capture this premium more effectively than its peers. Its disciplined rebalancing approach also helps. When it rebalances annually in December, the fund increases its exposure to stocks that have become cheaper relative to their peers and trims its exposure to stocks that have become more expensive. These disciplined bets against the market may allow RPV to more effectively capture the mean reversion behind the value effect. However, they may also cause it to overweight stocks with deteriorating fundamentals, which can increase risk.

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About Author

Alex Bryan

Alex Bryan  Alex Bryan, CFA, is director of passive strategies for North America at Morningstar. Before assuming his current role in 2016, he spent four years as an analyst covering equity strategies. He holds an MBA with high honors from the University of Chicago Booth School of Business.