The iShares MSCI USA Min Vol Factor ETF (BATS:USMV) seeks to build a portfolio with low volatility. It appears to have succeeded, as the ETF has seen limited declines YTD. What’s noticeable is that among the top holdings are some of the highest quality economics in the market. The USMV captures a quality factor well, which is also why the multiple is pretty high. While it does successfully limit volatility, value still matters and the earnings yield is too low relative to where reference rates are going. The fundamentals are good, but the return is insufficient.
A sectoral breakdown doesn’t exactly do the ETF justice because many of the stocks aren’t typical of their sector, and the value-weighted distribution that one comes to expect from ETFs isn’t present here.
Top Holdings (iShares.com)
The ETF is quite large with 173 holdings, but some groups do emerge. The first is waste management, which includes Republic Services (RSG), the company Waste Management (WM) and Waste Connections (WCN). These businesses benefit from fragmentation below them, meaning roll-up economy on the inorganic side, while also having long-term stable growth on the organic side from long-term commercial and municipal contracts. These services are necessary infrastructure. Waste management already accounts for 5% of the portfolio.
The healthcare allocation at 19% of the portfolio is more internally consistent, representing biopharma exposures. Gilead (GILD) is present, with its solid HIV exposures and high dividend yield, now finally beginning its credible path to growth. Vertex (VRTX) with its cystic fibrosis medications, also another cash generative market and resilient market, makes a presence. On later pages of the holdings we see Bristol-Myers Squibb (BMY) which dominates a lot of oncology. Merck (MRK) and other biopharma players also make an entrance providing their often resilient specialty medication exposures.
The next category is consumer staples at 11%. Here we have PepsiCo (PEP), Walmart (WMT) and other stalwarts. All should be resilient.
The top category is technically IT, but the exposures aren’t typical. Microsoft (MSFT) is in the USMV, again another cash generative, subscription based business, but before it are allocations like Cisco (CSCO), Texas Instruments (TXN) and Paychex (PAYX). These aren’t necessarily our favourites. TXN has a lot of automotive exposure, and Paychex is levered to the economy where employment will have to come down to beat inflation. CSCO is more infrastructural and solid. The good thing is as you go deeper into the holdings, the smaller IT exposures are more and more infrastructural like Motorola Solutions (MSI), Oracle (ORCL) and to some extent Alphabet (GOOG).
The declines YTD have been only 12%, which is ahead of the broader market which saw around 20% declines.
YTD Declines (Seeking Alpha)
While the object of limited volatility has been accomplished, the bigger concern is simply of value. As rates continue to rise, the market will be subjected to gravity. We don’t like that the PE of 20x implies only a 5% earnings yield. It barely runs ahead of the reference rates which are coming up to 4% nowadays. Rates will continue to rise as inflation persists, and regardless of what broad multi-sector portfolio you have it will decline. If you know that’s going to happen, why would you invest in it? With a 5% earnings yield and a 2% dividend yield, there really isn’t much scope for return nor a margin of safety to rely upon during the turmoil. While the fundamentals are resilient, they aren’t totally resilient, and you have to try a little harder that USMV to stay ahead of a complicated market.
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