Cambria Shareholder Yield ETF looks better than SPY over the long term

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Thesis

In my opinion, Cambria Shareholder Yield ETF (BATS:SYLD) is better for long-term investing than everyone’s favorite SPDR S&P 500 Trust ETF (NYSEARCA: SPY), the most liquid and popular passive index fund among retail investors. It’s about the structure of the fund which should theoretically continue to show abnormal returns in the future thanks to current macro trends. This is the thesis that I will explain to you in today’s article.

Why do I think so?

Let’s take a look at the key comparison metrics of SYLD and SPY:

Metric / Fund Name SLD TO SPY
ETF description The Cambria Shareholder Yield ETF uses a quantitative approach to investing in US stocks with high cash distribution characteristics. The initial screening universe includes stocks in the United States with marketing capitalizations greater than $200 million. The ETF is made up of 100 companies with the highest combined ranking of dividend payouts and net share buybacks, which are the key drivers of shareholder return. The ETF also screens for value and quality factors, including low leverage. SPY is one of the largest and most traded ETFs in the world, providing exposure to one of the best-known equity benchmark indices. While SPY can certainly appeal to investors looking to build a long-term portfolio and include large-cap US stocks, this fund has become extremely popular with more active traders as a way to switch between risky and safe assets. A look at SPY’s daily turnover reveals the short average holding period and popularity with active traders.
daily volume $8.5M $31.1 billion
Net assets $568.4 million $340.1 billion
Expense ratio 0.59% 0.09%
Investment objective Equity income Equities: United States – Large Cap
Fund type Actively Managed ETF Passive ETFs
Creation date May 14, 2013 January 22, 1993

Source: Author’s compilation based on cambriafunds.com, etfdb.com and Investing.com

At first glance, it may seem like I’m comparing apples to oranges, but I’m not. A passive long-term investor wants above all a good return over many years, and all that matters to him, apart from the return, is the degree of risk he takes on his position (volatility, maximum drawdown, etc.). If we have 2 ETFs which are managed with different frequencies (passively/actively), but have similar risks and do not differ significantly in terms of content complexity, I think it is reasonable to put them online and perform comparative analytical manipulations. Why not, if they cover roughly the same zone of the efficient frontier in terms of risk?

Chart
Data by YCharts

SYLD saw a bigger drop in 2020, outpacing SPY by 11.6%. This is because SYLD aims to achieve high total shareholder returns, and SPY’s primary goal is to replicate (SPX), which simply takes the biggest companies in the market indiscriminately (this also affects obviously the divergence of the expense ratios of the funds). Since broad market stocks tend to fall during hard selloffs with some multiplier relative to SPX (most stocks have a beta greater than 1), the maximum drawdown is in any case higher than what we let’s see with SPY. This is not unique to SYLD – for example, the Russell 2000 Value ETF (IWN) also has a similar excess of maximum drawdown (12.37%) with a similar excess in terms of volatility:

Chart
Data by YCharts

To stay on the risk/return ratio: the only difference between the 3 funds mentioned above is the denominator of the coefficient in question, ie the rate of return. Specifically, how quickly the maximum Covid time drawdown was caught up by each of the ETFs:

YCharts, author's calculations

YCharts, author’s calculations

Despite falling more steeply than SPY during the Covid recession, SYLD recovered much faster thanks to a more conservative approach – focusing on the most stable companies looking to increase total returns (buyouts + dividends). At the same time, the dominance over SPY can be observed on different time scales – since last year, 3 years, or since the launch of the youngest of the analyzed instruments – SYLD.

But how does Cambria manage to outperform the market while having volatility that does not deviate significantly from it?

According to SYLD’s prospectus, Cambria selects the top 20% of stocks in the initial universe of U.S. companies based on their total return prospects, then sorts them by price-to-book (P/B) ratio. , price/sales (P/S), price/earnings ratio (P/E), price/free cash flow ratio (P/FCF or P/CF) and enterprise multiple (EV/EBITDA). The first 100 stocks are then included in the SYLD portfolio which has a turnover rate of 51% of the average portfolio value (as of April 30, 2022).

Among the 102 companies that make up the fund’s portfolio (as of September 30, 2022), there is a strong overweight in value-related sectors such as consumer discretionary, financials, materials, energy and industrials:

Seeking Alpha, SYLD's Holdings, author's notes

Seeking Alpha, SYLD’s Holdings, author’s notes

It may seem that it is not diverse enough. But at the same time, SPY’s top 3 and 5 sectors account for 51.81% and 71.47% of its total portfolio, respectively. And most of the portfolio value is allocated to big tech companies that I believe peaked in the business cycle in 2021-22.

Seeking Alpha, SPY, author's calculations

Seeking Alpha, SPY, author’s calculations

Over the next few years, SYLD will likely continue to outperform the broader market and SPY in particular, as the current level of underinvestment in the Materials and Energy sectors predicts abnormal returns and a new bullish cycle of companies. high quality value producing and selling goods. This argument is not new: in the professional community of hedge fund managers, the thesis in favor of companies based on raw materials has been actively propagated for a few months. For example, below you can see a chart from Crescat Capital, which was one of the first to promote this topic.

Crescat Capital, newsletter [May 1, 2022]

Crescat Capital, newsletter [May 1, 2022]

Energy companies are far from the only beneficiaries of capital flight from tech stocks – the case for mining company ownership has never been more compelling, according to the latest [Oct. 19, 2022] newsletter of Crescat Capital. Analysts say that while we have seen general fundamental improvements across the industry, profitable mining companies are also trading today at their all-time low P/E ratios – this ratio currently matches at the 2008 low:

Crescat Capital, newsletter [October 19, 2022]

Crescat Capital, newsletter [October 19, 2022]

In my view, US-based consumer cyclical companies will also be among the beneficiaries of the ongoing de-globalization processes around the world (and most likely in the future) due to current geopolitical tensions. This is the opposite of what happened in the mid-1940s, when World War II ended and ushered in an increasingly globalized business environment.

The relationship between the G7 countries, which have sophisticated economies and democratic governments, and the two largest authoritarian and centralized nations in the Eastern bloc – China and Russia – has deteriorated rapidly. This indicates that trade with the autocratic East will continue to slump. It will need significant additional infrastructure spending in the coming years to achieve this transformationwhich will strategically help Western nations reduce their economic dependence on China, Russia and other foreign dictatorial empires.

Based on SYLD’s portfolio structure, we can see that this ETF is well positioned to make the most of the process described above because: a) it is only invested in the US; and b) 9 of the 10 largest holdings will directly benefit from national infrastructure development (if the same proportion is true for the remaining 90 stocks in the portfolio, the likelihood of abnormal returns is even higher):

etf.com, SYLD, author's notes

etf.com, SYLD, author’s notes

It is impossible not to mention the financial sector – the most important in the SYLD structure. If you take out all the companies within the ETF, you will see that the financial sector is mostly made up of regional banks and insurance companies:

Author's selection based on etf.com

Author’s selection based on etf.com

In a recent Bear Traps report, Larry McDonald quotes a banking veteran (he does not name the gentleman) who writes the following about regional banks:

Not to mention any particular bank, but having been in the industry for 35 years, I must say that the regional banks are as undervalued as I have seen. The market simply hasn’t priced in a higher interest rate structure for longer that will significantly boost ROAs to 1980s and 1990s levels.

Source: Bear Trap Reports, [October 24, 2022]emphasis added by author

My guess is that the drop in inflation the market has now priced in will prove wrong again – many pundits agree we’re in for an extended period of “inflation well above the 2% target” which will force the Fed to deviate from its usual model of permanently stimulating economic growth with its too soft policy of low rates. As long as interest rates remain above target, banks’ current market multiples in a widening spread environment will provide excellent opportunities for long-term investors to gain alpha through both operational growth (increased net interest income and margins) and a combination of buybacks and dividends, as pursued by SYLD.

Conclusion

I believe that an average constant dollar investment in the Cambria Shareholder Yield ETF offers patient investors (I would use a minimum 5-6 year horizon) the opportunity to achieve above-SPX alpha at roughly the same level of risk – the world is going through a global rotation of assets from one sector to another, and SYLD is the host in this case.

The obvious risk, of course, is the lack of diversification – SYLD is not really sufficiently committed to certain individual sectors. However, this has an advantage: the (under)outperformance of our investments depends on the underweight and the overweight.

So I would recommend considering SYLD for the long term.

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