AVDV: fishing for (almost) the cheapest companies in the world

Avantis International Small Cap Value ETF (AVDV) is an actively managed fund that combines size, value and quality factors in a portfolio of non-US developed country stocks.

Managed by American Century Investment Management Inc., AVDV had total assets under management of approximately $1.4 billion as of February 3.

Launched in September 2019, the fund offers unique exposure to the corner of global financial markets that is not so easy to reach for US retail investors (given that most of the stocks it picks are not listed in the country or have totally lackluster liquidity on the counter), with an active management component on top.

Even U.S. small-cap stocks, let alone those traded in less liquid markets, are mostly underhedged, undertracked by analyst themes, and often overlooked or intentionally overlooked by institutional players, which creates many opportunities for investors looking for grossly mispriced stocks. and willing to wait patiently for a capital catalyst to bring a valuable thesis to fruition. Truly a contrarian’s paradise.

Since AVDV is free to make investment decisions within its selection pool, it can exploit this mispricing, placing bets opportunistically and ignoring stocks it sees as lifeless, with zero or negative capital appreciation potential.

And this strategy is only available for 36 basis points per year, while most of its international counterparts have an expense ratio of at least half a percentage point. And wait, a 2.4% dividend yield is another nice bonus that comes with this value portfolio to boot. The mix with the investment allure, right?

However, the risks inherent in even the quality-tested international small-cap value strategy (considering cash flow, among other things) are substantial enough to give the ETF a pass. In my opinion, it’s the FX question that didn’t go anywhere. In its current version, the fund’s portfolio is biased towards Japanese and UK equities, with ~24.7% and ~16.5% allocated, as of February 3. The yen’s slow period may not be over, even though the currency is currently at the weakest level against the US dollar in five years, as the safe-haven JPY attracts bears given the rises looming interest rates in the United States. For the British pound, the bullish case is also difficult to defend, given the reasons I have discussed. in the article. Speaking of other currencies like the Euro (AVDV is a long position in French, German, Italian, Austrian stocks, etc.), I wouldn’t say they have the potential to appreciate against the Euro. USD this year at least, precisely because of the persistence of a dovish attitude. in the euro zone, even though inflation has recently surprised on the upside.

AVDV is compared to MSCI World ex USA Small Cap Index. From at the end of Januarythe index had 2,588 constituents compared to just 1,307 stocks in the ETF’s portfolio.

Please note that, like a few ETFs I have already reviewed on Seeking Alpha, AVDV does not necessarily only hold companies with a market value between $300 million and $2 billion, which are generally considered small caps. . His definition of a small cap company is what I would rather call mercurial. As detailed on page 2 of the prospectus,

When selecting the fund’s investments, the portfolio managers take into account the market capitalization distribution of all companies in each country in which the fund invests, which means that a company of a given size can be considered as small in one country, but not in another.

A small but necessary quality ingredient is added to the mix that is more likely to ensure valuable traps are not eligible. No one wants an already risky international small-cap portfolio to be overflowing with low-quality stocks on the brink of collapse. As explained on the same page, the adjusted cash flow to book value ratio is the main measure used in the evaluation of profitability, although other ratios not mentioned can also be applied, if necessary.

For the value factor, portfolio managers use adjusted B/P; I personally think this metric is a sub-optimal choice, although it’s worth noting that it helps assess value in all industries, including finance, where cash-based metrics are losing steam. relevance.

Industrials (22.7%), Materials (19.2%) and Financials (17.4%) are currently AVDV’s top allocations. Listed in London Marks & Spencer Group (OTCQX:MAKSF) is, for now, its flagship value, with nearly 0.8% of net assets. It is a mid-cap UK retail company, with a market value of around £4 billion. With a P/E of around 134x, the stock looks like an odd mix in the value mix, but the problem with the ratio is net income margin compression, which should be temporary. If evaluated from a different angle, it has a staggering 20% ​​FCFF return (FCFF/EV) and an LTM price/sales of around 0.39x. Another way of saying, the company is incredibly cheap.

Peers

The only closest counterpart to AVDV that I know of is the passively managed iShares International Developed Small Cap Value Factor (ISVL) ETF, with a net expense ratio of 30 basis points. The downside is that ISVL’s methodology is limited by the index it tracks, the FTSE Developed ex US ex Korea Small Cap Focused Value Index. ISVL is a much more concentrated and Canadian-focused new investment vehicle (AVDV only holds 9% of net assets in Canadian equities) with less than a year on the books. However, the main similarity with AVDV is its focus on the industrial/material/financial trio.

Return

Although promising at first sight, AVDV’s strategy did not generate excess returns compared to the S&P 500 ETF (IVV), which was also much weaker than its American counterpart, the Avantis US Small Cap Value Fund ( AVUV), at least for now, although I should admit that it always takes time for a truly contrarian thesis to come to fruition.

The table below presents the CAGRs for the period from September 30, 2019 to January 31, 2022:

Yet, as the data on its website illustrates, it has significantly outperformed the benchmark in one year, indicating that its portfolio management team is very capable.

Also, it should be noted that AVUV and AVDV are more or less correlated with IVV, although the latter focuses on entirely different market/country segments.

Final Thoughts

AVDV could look like an ETF with clear investment appeal, especially considering that it focuses on the (almost) cheapest companies in the world, excluding less stable and therefore riskier emerging markets , with the exception of a single Hong Kong-listed Chinese stock (labeled as such in the holdings dataset available on the AVDV website), Fullshare Holdings (OTCPK:FLLHF) with a weighting of 0.2%. The adjusted cash flow analysis included in the quality assessment is yet another strength.

In an environment where the richly valued U.S. market is still experiencing bouts of volatility amid seemingly unexpected valuation resets, like the epoch-like one we recently saw in the case of Meta Platforms (FB), the inherently inexpensive universe small cap stocks could offer relief to investors looking for safety.

It is well diversified, with only ~6.4% allocated to the ten key holdings, which is better than ISVL’s 12%. Asset flows are extremely robust, with healthy volumes and changes in assets under management indicating growing investor interest. As I said above, the LTM yield of around 2.4% is a nice by-product of his value strategy. It all adds up to its looks.

However, the main drawback is the FX issue. The depreciation of the currencies of the advanced economies to which it is most exposed can harm otherwise strong returns if it is reached. So, to express a bullish view on AVDV, I would simultaneously have to explain why I’m bearish on the USD, while I’m certainly not assuming impending interest rate increases.

That said, investors looking for exposure to underrated players in the lower echelon of the stock market can take a closer look at the Avantis US Small Cap Value Fund which I have reviewed twice, the higher rating recent being published in December.