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Cambria: ETF Eyes Global Value
12/31/2014 7:00 am EST
Our latest recommendation combines two long-established investment themes: global diversification and value investing, explains Nicholas Vardy, in The Alpha Investor Letter.
Launched in March 2014, the Cambria Global Value ETF (GVAL) tracks the Cambria Global Value Index. This new Index takes the well-established principles of value investing as articulated by Benjamin Graham and David Dodd and applies them to global stock markets.
Graham and Dodd epitomize the long-term view of value investing by not focusing on short-term or expected earnings, but instead, using historical earnings that have been smoothed over the long-term.
The long-term philosophy of stock market valuation was given new life by 2013 Nobel Prize-winning Yale University economist Robert Shiller through his own articulation of the cyclically adjusted price-to-earnings ratio (CAPE).
CAPE is a variation of the traditional price/earnings ratio (P/E). It uses a trailing 10-year average of earnings rather than simply using the most recent year. By taking a 10-year average of the P/E, it smoothes out the extremes of the business cycle.
The Cambria Global Value ETF uses an approach similar to Schiller’s, but applies the CAPE methodology to 45 major world markets. It then invests in cheap companies in the cheapest markets in the world. Cambria’s investment universe of 45 countries includes both developed and emerging markets.
Cambria ranks these markets by valuation, using CAPE as an initial screen. It then selects companies within these markets that trade at discounts to their intrinsic value, according the principle set out in Graham & Dodd’s “Security Analysis.”
Cambria then screens for stocks with market caps larger than $200 million. After yet an additional screen to avoid over-concentration in any single country, Cambria generates—and invests in—a portfolio of 100 global value stocks.
The Cambria Global Value ETF has an additional secret weapon that should boost its long-term returns. Only 53% of its portfolio is invested in large-cap stocks. The rest is invested in small- and mid-cap stocks.
This is important for two reasons. First, all other things being equal, a focus on small-cap stocks should generate higher returns over the long-term.
The countries Cambria Global Value ETF often invests in are among the worst performers of recent years—a veritable 'rogues gallery of countries' such as Brazil, Spain, Israel, Italy, Ireland, Russia, Austria, Portugal, Greece, the Czech Republic, and Hungary.
Looking at that list of countries may make you feel a bit queasy. That queasy feeling you have is precisely why value investing is not easy. But here’s why I am overcoming my own hesitations and recommending Cambria Global Value ETF.
First, global stock markets have been out of favor for so long that they are far overdue for a monster rally. Once global stock markets do take off, they can double and triple in relatively short order. I don’t see the same kind of upside in the US stock market over the same time frame.
Second, the markets in which Cambria Global Value ETF invests are the cheapest markets in the world. So, when global markets do rebound, I expect the bounce in the cheapest markets to be the sharpest and quickest.
Third, like everything else in life, investment markets do revert to the mean. Stock markets that are overvalued—like the United States—do tend to stagnate, and undervalued markets do tend to recover, over time.
Given the valuation gap between the United States and the rest of the world, the case for Cambria Global Value ETF is more compelling than ever.
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