Financial advisors continuously search for investment strategies that align with their clients’ diverse goals. While the S&P 500 remains a cornerstone for broad U.S. large-cap exposure, understanding nuanced approaches within this space is crucial.
The VictoryShares Free Cash Flow ETF (VFLO) is a distinct U.S. large-cap offering that may add value to portfolios. VFLO tracks the Victory U.S. Large Cap Free Cash Flow Index (the Index), which follows a rules-based, systematic approach to screening stocks in or out during each quarterly rebalance.
based, systematic approach to screening stocks in or out during each quarterly rebalance.
Both the Index and the S&P 500 originate from a U.S. large-cap universe, Lance Humphrey, head of portfolio management with the VictoryShares and Solutions team at Victory Capital, said on ETF Prime recently.
However, the Index differentiates itself by immediately narrowing its focus to 400 large, profitable companies, and it excludes financials and real estate names off the bat. This omission of sectors is strategic because free cash flow analysis is less effective in the financials and real estate sectors, according to Humphrey.
Key Differentiators: Value, Concentration & Objectives
The S&P 500 is widely regarded as a way to gain passive exposure to U.S. large-cap companies, commonly considered a large-cap core holding, according to Humphrey. The Index, however, takes an approach “to identify a specific set of U.S. large-cap companies,” he noted.
This leads to an important distinction: VFLO is considered a large-cap value ETF, but the emphasis on valuation and quality sets it apart from the broader market exposure offered by the S&P 500.
What drives this value exposure?
From these 400 large, profitable companies, the Index screens for the 75 with the highest free cash flow yield. It will then eliminate the 25 slowest-growing companies from this selection, leading to a portfolio of quality companies, trading at a discount with favorable growth prospects. This approach to identifying companies with high free cash flow (FCF) yields is a key driver of the Index’s value exposure.
Another significant difference lies in concentration. The S&P 500, with its 500 constituents and annual rebalancing, aims for broad diversification. In contrast, the Index employs a more concentrated approach, comprising just 50 stocks, which are rebalanced quarterly. The rebalance frequency allows the ETF to focus on the current opportunity set. This higher concentration means VFLO is designed to provide a more targeted exposure to its chosen subset of companies.
“I think of the S&P 500 as trying to achieve broad-based U.S. large-cap exposure. The VFLO Index is designed to provide a subset of that with a focus on valuation and quality,” Humphrey said.
Therefore, for clients looking for a more concentrated approach with an emphasis on valuation and quality within the large-cap universe, VFLO presents a compelling alternative to the S&P 500.
VettaFi LLC (“VettaFi”) is the index provider for VFLO, for which it receives an index licensing fee. However, VFLO is 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.
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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. The Fund has the same risks as the underlying securities traded on the exchange throughout the day. ETFs may trade at a premium or discount to their net asset value.
Index Funds invest in securities included in, or representative of securities included in, the Index, regardless of their investment merits. The performance of the Fund may diverge from that of the Index.
Investing in companies with high free cash flows could lead to underperformance when such investments are unpopular or during periods of industry disruptions. The fund 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, trade disputes, 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 Victory U.S. Large Cap Free Cash Flow Index aims to select high quality companies from its starting universe by applying profitability screens. It then selects companies with the strongest free cash flow yield that exhibit higher growth. The Index is rebalanced and reconstituted quarterly. This Index calculates free cash flow yield by dividing expected free cash flow by enterprise value. Expected free cash flow is the average of trailing 12-month FCF and next 12-month forward free cash flow. Enterprise value (EV) measures a company’s total value, often used as a more comprehensive alternative to equity market capitalization.
VictoryShares ETFs distributed by Victory Capital Services, Inc. (VCS). VCS is not affiliated with VettaFi.
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