2013 was truly a landmark year for the stock market. A yearly return of about 30% for the S&P 500 marks its biggest yearly percentage gain in a long time. However, the surge in stocks has left many investors scratching their heads as valuations clearly surged above their comfort zones. This created a "dearth of value."
Pure value strategy to the rescue
Yet investors can still find long-term value in an ETF. As the name suggests, the Guggenheim S&P 500 Pure Value (NYSEMKT:RPV) ETF employs a pure value strategy and selects S&P 500 stocks that meet its extensive screening criteria. Primarily, the ETF screens for stocks with the most attractive valuation multiples, including price-to-earnings, price-to-sales, and price-to-book ratios. There are currently about 119 stocks in its portfolio.
Unlike most ETFs, which weigh their components based on their market capitalization, this pure value ETF assigns scores to its components on the basis of their value characteristics and weights them accordingly. The stocks that appear to offer the best value are given the highest weighting.
Risks to consider
Being a style-specific ETF, the Guggenheim S&P 500 Pure Value ETF is prone to concentration risk. This means that if the pure value strategy were to fail in a given market environment, all of its constituents would take a beating. This could result in a dismal performance for the ETF.
Nevertheless, it shouldn't be forgotten that the ETF represents the large-cap space, which gives it an added layer of cushion and a high margin of safety. This helps to reduce the overall volatility that you would normally associate with a focused ETF.
The ETF charges an expense ratio of 0.35% and pays out a 1.13% dividend yield. However, the striking feature about this ETF is the increase in its asset base from just above $80 million a year ago to about $560 million now. This ETF has clearly gained a tremendous amount of popularity among investors.
This surge in its asset base can primarily be attributed to both marketwide factors and the unique investment strategy employed by the ETF. At a time when market valuations had surged beyond ordinary proportions, value-seeking investors found the pure value strategy particularly appealing, as it ensured them exposure to only those stocks that offer the best value. And this trend is expected to continue as market valuations continue their march higher.
To highlight the efficiency of the ETF's investment strategy, this chart compares its returns with those of the similar iShares S&P 500 Value (NYSEMKT:IVE) ETF and the index-tracking SPDR S&P 500 (NYSEMKT:SPY) ETF.
Although the two value ETFs seem to be similar in nature, as they follow the same investment principal and have the same parent index, we see a startling difference in their returns. The difference, of course, lies in the "pure value" strategy.
While the Guggenheim value ETF weights its components on the basis of their value scores, its iShares counterpart weights its components based primarily on their market capitalization, paying less attention to their value characteristics.
Further, the iShares value ETF lacks the value niche that the Guggenheim ETF has created with its relatively small portfolio of 119 pure value stocks. The iShares ETF has almost 342 stocks in its portfolio -- a relatively large spread for a focused strategy like value investing. The large number of stocks in its portfolio somewhat diversifies it away from its core investment principal of high value.
The bottom line
Equity prices are near record-high territories, and opportunities are limited. However, smart investors can find good opportunities when they're most scarce. Given the present environment, where many investors are skeptical of entering the market, this pure value ETF looks especially appealing.
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Ankush Shaw has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.