Originally published April 24, 2024
Utilizing factors as part of an investing strategy can potentially enhance diversification, improve returns, and manage risk or volatility.
Common style factors include growth, value, quality, momentum, and size. Many broad indexes add unintentional factor tilts to portfolios. This makes it important for investors to consider their exposures and balance factor tilts to prepare a portfolio for all market environments.
See more: “VFLO or SFLO: Which Free Cash Flow ETF Is Right for You?”
Which Factors Should Investors Target?
Factors tend to outperform during different market environments. It’s hard for even the most experienced investors to predict which factors will win. That makes it essential for portfolios to have balanced exposure across multiple diversified return drivers.
Value and growth are two of the best-known and most popular factors. They notably tend to work in opposite directions. This is important to consider as large-cap benchmarks, like the S&P 500 Index and Russell 1000 Index, tend to introduce a growth tilt to portfolios, leaving portfolios underexposed to value stocks.
One way investors can solve for this is to complement their growth exposure with free cash flow ETFs such as the VictoryShares Free Cash Flow ETF (VFLO) and the VictoryShares Small Cap Free Cash Flow ETF (SFLO).
How VFLO and SFLO Implement Factors
VFLO and SFLO can be used to introduce factor tilts to a portfolio. The free cash flow ETFs offer three core factor exposures: quality, value, and growth.
VFLO and SFLO provide exposure to high-quality companies trading at a discount that have favorable growth prospects. Each focus on companies with higher expected free cash flow yields and high expected growth rates. This sets them apart from other free cash flow ETFs.
Notably, a high free cash flow yielding large value approach has outperformed traditional approaches by nearly 600 basis points annualized over the past 31 years¹. However, moving down the market capitalization range into the small-cap segment, the quality factor is particularly impactful as the space includes more low-quality companies.
Under the Hood of VFLO and SFLO
VFLO seeks to deliver value, growth, and quality exposure through its unique methodology. The fund’s underlying index starts by selecting the 400 largest profitable U.S. companies. The index then selects the 75 names with the highest free cash flow. It analyzes both trailing and future expected free cash flow.
Furthermore, VFLO’s index applies a growth filter by selecting the top 50 stocks with the highest expected growth scores. This filter is designed to eliminate companies that have high free cash flow due to weak growth prospects. Finally, the index weights each security based on the size and yield of a company’s free cash flow.
SFLO utilizes the same underlying methodology with some nuances that help it navigate the small-cap space. First, SFLO’s underlying index pulls from a larger starting universe, comprising 2,500 securities, aiming to solve for capacity and liquidity issues. Additionally, SFLO incorporates robust liquidity requirements to maximize trading efficiency.
VictoryShares’ methodology for its free cash flow ETFs provides exposure to a powerful mix of factors. While the value and quality aspects suggest that these funds look to isolate profitable companies that are not overvalued, the growth angle indicates these funds are also targeting stocks that have the potential for strong returns in the future.
For more news, information, and analysis, visit the Free Cash Flow Channel.
VettaFi LLC (“VettaFi”) is the index provider for VFLO and SFLO, for which it receives an index licensing fee. However, VFLO and SFLO are not issued, sponsored, endorsed, or sold by VettaFi, and VettaFi has no obligation or liability in connection with the issuance, administration, marketing, or trading of VFLO and SFLO.
1/ Victory Capital Research conducted through Factset analyzing S&P 500 constituents (ex Real Estate & Financials) broken into quintiles based on trailing free cash flow yield with the lowest quintile returning 7.38% and the highest quintile returning 15.83% and the S&P 500 returning 9.96% within the time span of 12/31/1991 – 6/30/2023.
Disclosure Information
Carefully consider a fund's investment objectives, risks, charges, and expenses before investing. To obtain a prospectus or summary prospectus containing this and other important information, visit http://www.vcm.com/prospectus. Read it carefully before investing.
All investing involves risk, including the potential loss of principal. Please note that both Funds are new ETFs with a limited history. The ETFs have the same risks as the underlying securities traded on the exchange throughout the day. Redemptions are limited, and commissions are often charged on each trade. ETFs may trade at a premium or discount to their net asset value. The ETFs invest in securities included in, or representative of securities included in, the Index, regardless of their investment merits. The performance of the ETFs may diverge from that of their respective Indexes. Investments concentrated in an industry or group of industries may face more risks and exhibit higher volatility than investments that are more broadly diversified over industries or sectors. Derivatives may not work as intended and may result in losses.
Additional Information
Large shareholders, including other funds advised by the Adviser, may own a substantial amount of the ETFs’ shares. The actions of large shareholders, including large inflows or outflows, may adversely affect other shareholders, including potentially increasing capital gains. Investments in small- and mid-cap companies typically exhibit higher volatility and may involve greater risks than those associated with larger, more established companies. Investing in companies with high free cash flows could lead to underperformance when such investments are unpopular or during periods of industry disruptions.
The ETFs could also be affected by company-specific factors that could jeopardize the generation of free cash flow. The value of your investment is also subject to geopolitical risks such as wars, terrorism, environmental disasters, and public health crises; the risk of technology malfunctions or disruptions; and the responses to such events by governments and/or individual companies. The information in this article is based on data obtained from recognized services and sources and is believed to be reliable. The securities highlighted, if any, were not intended as individual investment advice.
Other Notes:
The S&P 500® Index is a market-capitalization-weighted index that measures the performance of the common stocks of 500 leading U.S. companies.
The Russell 1000 Index is a market-capitalization-weighted stock market index that tracks the highest-ranking 1,000 stocks in the Russell 3000 Index.
A basis point is a common unit of measure for interest rates and other percentages in finance which equates to one hundredth of 1 percentage point.
Free cash flow is the remaining cash a company has after covering all expenses. It can be used to invest in growing the business, pay dividends or pay down debt.
Distributed by Foreside Fund Services, LLC (Foreside). Foreside is not affiliated with Victory Capital Management Inc. (VCM), the Fund's advisor. Neither Foreside nor VCM have affiliation with VettaFi.
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