I’ve discussed small-caps over the past year, given the fact that passive small-cap averages have largely gone nowhere. A lot of small-cap passive averages have “zombie companies” which are saddled with high debt and have low margins. These companies may not survive in a higher for longer interest rate environment. As such, those companies have held back those passive averages. Well - if that’s the case, why not consider some active portfolio management that can eliminate those stocks? One fund worth considering that does just that is the Dimensional US Small Cap Value ETF (NYSEARCA:DFSV).
This is an actively managed ETF designed and managed by Dimensional Fund Advisors in February 2022. DFSV invests in a portfolio of small-cap value stocks, with exposure designed to track the performance of an index of US companies. This index is created using Dimensional Fund Advisors’ factor-based strategy and combines factors documented in multiple academic papers which have been shown to generate long-term performance. The process is fundamentally driven, with it looking at a company’s price, usually based on price/book or price/cash flow or price/earnings ratios, as well as relative profitability which compares a company’s earnings or profits regarding book value or assets.
A Look At The Holdings
I’m a big fan of removing company specific idiosyncratic risk, and on that end, DFSV delivers. No position makes up more than 0.76% of the fund, making this extremely diversified and more about the fundamental factors tracked rather than a select number of stocks driving performance.
Some of these companies are ones you may never have heard about. Amkor Technology, Inc, for example, offers outsourced semiconductor packaging and test services. PVH Corp is a global apparel company with brands such as Calvin Klein and Tommy Hilfiger. Mohawk Industries, Inc is one of the world's largest flooring manufacturers in the consumer discretionary sector. Diverse companies from all sectors here.
Sector Allocations
This clearly has a value tilt, which the sector composition is proof of.
Financials make up the largest allocation at nearly 26% of the fund, followed by Industrials and Consumer Discretionary. I actually like the Financials sector here in the small-cap space given we are over a year removed from the regional bank crisis of last year, and the stocks here are very much on the undervalued end of the spectrum.
Peer Comparison
Since this is active, it’s worth comparing this to the iShares Russell 2000 Value ETF (IWN) which is passively managed. When we look at the price ratio, we find that DFSV has substantially outperformed since inception. The active allocation, and avoidance of zombie companies, has worked relative to passive here.
Pros and Cons
On the plus side, DFSV benefits from Dimensional’s extensive experience and research on factor-based investing (the approach they use to determine which securities are most appropriate). This knowledge could translate into better risk-adjusted returns, over the long run. The fund is very well diversified, active, and has the performance to back up the use of the methodology. In the small-cap space, this is especially important, as I suspect there are very real risks out there that many small-cap companies won’t survive in the next several years.
The downside? Well - it’s that active management, too. Yes, it’s a positive now, but it can be a double-edged sword. Active management in general has a hard time consistently outperforming passive benchmarks. The other negative (to some) is the concentration risk with Financials being at the top (again - I like this but can understand why others wouldn’t). And finally, it’s got a short track record, meaning it’s difficult to know whether it will continue to perform and whether its investment methodology is consistent over the long term.
Conclusion
For investors who want exposure to the small-cap value segment of the US market, the Dimensional US Small Cap Value ETF is worth considering. By using a factor-based investment approach, a focus on valuation and profitability, and Dimensional’s experience and expertise, DFSV offers something different. I think it’s a good fund, and small-caps remain one of the most interesting parts of the marketplace here, in my view.
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