Value ETF Actively Managed by Artificial Intelligence Shines Amid Market Turmoil

Over 2022, investors have faced a staggering range of market conditions, starting the year with concerns regarding the risk of stagflation, then shifting to a speedy and aggressive response from central banks to tackle persistently high inflation, which then prompted concerns about the potential for a deep recession. Add in geopolitical disruptions and the global energy crisis, it’s no wonder equities and bonds have posted steep declines over 2022.

Amid the turmoil and uncertainty, value funds have quietly been garnering assets and as of October 31, full-year flows to value funds have reached $94 billion, setting a new annual flow record.[1] This is particularly noteworthy as value funds have, for years, been eclipsed by flows into growth funds.

At Qraft, we have long believed that value strategies present a compelling investment opportunity, particularly active strategies that identify value in a more nuanced manner. The Qraft AI-Enhanced Next Value Fund (NVQ) is one such value strategy, investing in stocks identified using our proprietary artificial intelligence (AI) tools that incorporate measures of intangible assets in stock valuation.

Over the past 12 months (as of October 31, 2022), NVQ has delivered strong results, returning +3.76%, up over 11% relative to the MSCI USA Enhanced Value Index, a widely used value benchmark, which was down -7.44%. Over the year to date, NVQ was up nearly 13% relative to the MSCI USA Enhanced Value Index. Results are similar when comparing NVQ to the iShares MSCI USA Value Factor ETF (VLUE), a passive ETF designed to track the MSCI USA Enhanced Value Index.

For the most recent month-end and standardized performance, please visit www.qraftaietf.com. 

Qraft’s AI operates free of emotion, absorbing, analyzing, and processing a vast amount of market and security level data to identify our highest conviction names suitable for inclusion in the portfolio. Over the past 12 months, NVQ outperformed VLUE driven by contributions from both security selection and sector allocation:

NVQ’s strong performance over the last year has earned it a top spot among peers, ranking in the 5th percentile among over 400 peer strategies in the Morningstar Mid-Cap Value Category for the 12-month period ended October 31, 2022.[2]

The Intangible Asset Approach
In general, a “value stock” refers to shares of a company that trade at a lower price relative to its fundamentals – such as dividends, earnings, or sales – making the stock appealing due to its “discount to intrinsic value.”

Value investing, long proven in academia, does face a key criticism: accounting standards do not allow for the recognition of fair market value of certain intangible assets, including goodwill, brand recognition, and intellectual property such as patents, trademarks, and copyrights, to name a few. However, intangible assets that have been acquired by a third party are recorded on the balance sheet and in 2020, intangible assets accounted for 90% of the S&P 500’s market value.[3]

However, many intangibles have not been quantified through an acquisition. Assessing the value of these unquantified assets is where the Qraft AI-Enhanced Next Value Fund sets itself apart.

AI-Enhanced Next Value (NVQ)

At Qraft, we use machine learning, an artificial intelligence technique, to quantify specific aspects of the intangible economy, allowing us to assess a company’s intrinsic value more accurately. Our AI then determines a return prediction score derived from Qraft’s deep neural network. Each company is ranked on its return prediction score and the portfolio is constructed with the goal of maximizing alpha while taking into consideration both the AI scoring as well as portfolio constraints designed to manage risk, including caps on the weights of sectors and individual names.

We believe the predictive power of Qraft’s AI and our adjustment for intangible assets represent a superior approach to value investing. Our actively managed portfolios are updated monthly, allowing us to rotate into potential winners that meet our definition of value and rotate out of names that no longer appear compelling.

For example, over the last year, NVQ has had positions of varying size in Cigna, Valero Energy, and Archer-Daniels Midland, each which contributed significantly to NVQ’s return over the past 12 months, but not all of which have been constituents of VLUE, the ETF tracking the MSCI USA Enhanced Value Index.  However, based on our assessment of company data and intangible value, each is a value stock in our investible universe.

In our view, an additional advantage of active management is the freedom to sell or avoid names that may be a meaningful holding of the benchmark tracking ETF, but which our AI does not find compelling.

For example, NVQ has not held or maintained positions in the top five stocks in VLUE, which represent 20% of the VLUE’s market value. Notably, each of these stocks has experienced negative returns over the last 12 months:

Current Positioning and Outlook for Value
Historically, value stocks have outperformed growth stocks in rising rate environments.[4]  Conversely, when interest rates have fallen, growth stocks have outperformed their value counterparts.

Even with nascent signs of easing inflation, consumer prices remain well above comfort levels, and the US Federal Reserve is expected to continue to raise rates to combat inflation – despite the pain rising rates bring to households and businesses. In this environment, we expect value stocks to exhibit strong return potential relative to growth stocks.

In early November, the AI engine that drives NVQ added most significantly to the Energy sector (+15.7% to 23.1% of the portfolio) and significantly reduced allocation to Financials (-24.8% to 18.1% of the portfolio).

Among names added to the portfolio in the November portfolio update were Marathon Petroleum (MPC, 4.4% of the portfolio), Valero Energy (VLO, 4.0% of the portfolio), and Phillips 66 (PSX, 3.7% of the portfolio). At these initiation weights, each name was in NVQ’s top 10 holdings as of November 3.

Among names removed from the portfolio were Truist Financial (TFC, previously 4.4% of the portfolio), American International Group (AIG, previously 3.3% of the portfolio), and M&T Bank Corp (MTB, previously 2.3% of the portfolio). All three of these names were in the top 10 holdings prior to the rebalance.

For more information on NVQ, Qraft Technologies, and our application of artificial intelligence in the investment process, please visit https://qraftaietf.com/.

[1] https://www.ssga.com/library-content/pdfs/etf/us/monthly-flash-flows.pdf

[2] Morningstar rankings are based on a fund's average annual total return relative to all funds in the same Morningstar category. Fund performance used within the rankings, reflects certain fee waivers, without which, returns and Morningstar rankings would have been lower. The highest (or most favorable) percentile rank is 1 and the lowest (or least favorable) percentile rank is 100.

[3] https://www.oceantomo.com/intangible-asset-market-value-study/

[4] https://am.jpmorgan.com/hu/en/asset-management/institutional/insights/portfolio-insights/value-vs-growth-investing/