VAMO: Too Complicated For My Tastes

The Cambria Value and Momentum ETF (BATS:VAMO) is an actively managed ETF that combines 'Value' and 'Momentum' factors in selecting securities. It also hedges against market risks via S&P 500 futures.

While I am impressed by VAMO's outperformance in 2021 and 2022, I am concerned that the two factors chosen by the fund, 'Value' and 'Momentum', have historically worked counter to each other. By combining them, investors may end up with a mediocre underperforming portfolio.

I am also concerned there is no clear guidance on what market valuations the fund will start hedging, as well as what is the manager's definition of a downtrend. Without these details, it is difficult for analysts to determine how much of the fund's underperformance from 2016 to 2020 was due to the stock selection factors and how much was from the S&P 500 futures hedge. I advise avoiding this complicated strategy.

Fund Overview

The Cambria Value and Momentum ETF is an actively managed ETF that quantitative selects a portfolio of equities that score well on both value and momentum factors.

The VAMO ETF has $118 million in assets and charges a 0.59% expense ratio.

Strategy

The VAMO ETF starts by ranking the universe of domestic equities by value and momentum factors. It then averages the two rankings, and selects the top 100 ranked stocks. The portfolio is updated quarterly. The fund also uses S&P 500 futures to hedge the 25-50% of the portfolio if the broad U.S. stock market is in a downtrend. It may hedge a further 25-50% of the portfolio if the U.S. stock market is 'expensive' on valuation metrics (Figure 1).

Portfolio Holdings

Figure 2 shows the VAMO ETF's asset allocation and sector weights as of December 31, 2022. The VAMO ETF was heavily weighted in Energy (34.7%), Financials (21.7%), and Materials (18.4%).

Investors should note that as of March 15, 2023, the fund has hedged 47.5% of its exposure via S&P 500 Futures, presumably because it quantitatively sees the stock market is in a downtrend and / or valuation multiples are stretched (Figure 3).

Distribution & Yield

The VAMO ETF pays a modest quarterly distribution with trailing 12 month distribution of $0.30 / share or 1.2% trailing yield.

Returns

The VAMO ETF has done well in the short term, with 1 and 3 Yr average annual returns of 7.2% and 13.9% respectively to February 28, 2023. However, its long-term returns have been far more modest, at only 3.5% average annual returns over 5 years (Figure 4).

The main driver of VAMO's short-term returns were a superb 2021 and 2022, when the fund returned 32.2% and 8.5% respectively. However, historical annual returns prior to 2021 were poor, with losing years more often than winning years (Figure 5).

When Value And Momentum Meet...

Thinking about the different macro drivers to equity returns, it is interesting that the manager chose to combine the 'Value' factor and the 'Momentum' factor into a single fund.

Historically, these two factors worked counter to each other, as 'Value' is typically associated with cyclical industries such as Financials, Industrials, and Energy. On the other hand, the 'Momentum' factor was almost synonymous with 'Growth' investing in the past decade, characterized by 'expensive' stocks in Information Technology, Communications, and Consumer Discretionary.

It is no wonder that a strategy emphasizing high 'Value' and 'Momentum' factors actually got very mediocre results for many years, as investors likely ended up with companies that were neither value nor momentum.

However, that distinction changed dramatically after the COVID-19 crisis, as cyclical sectors such as Energy and Materials were crushed by the pandemic. The subsequent economic recovery led to shortages in raw materials and huge rallies in companies providing those commodities.

In fact, by mid-2021, many 'Value' companies had replaced 'Growth' companies in the 'Momentum' indices as they displayed stronger short-term price momentum. I believe that is the primary reason why the VAMO ETF performed well in 2021 and 2022, because for the first time in many years, 'Value' and 'Momentum' converged.

Will This Trend Persist?

However, going forward, the question for VAMO investors is whether the past two years was an anomaly or the new normal? In other words, will market momentum continue to be led by 'Value' companies? If so, VAMO should continue to do well; if not, then VAMO may return to its mediocre performance from 2016-2020.

The problem, as I see it, is that the downside of being wrong appears far greater than the upside of being right. From 2016 to 2020, the VAMO ETF underperformed the 'market', as represented by the SPDR S&P 500 ETF Trust (SPY), by 8.0%, 16.0%, 7.1%, 36.5%, and 23.9% (Figure 6).

Whereas in 2021, VAMO only outperformed the SPY ETF by 3.6%. VAMO's outperformed the SPY by 26.7% in 2022, however, it is unclear how much of the outperformance is due to the 'Value/Momentum' factor and how much is because the ETF shorted S&P 500 futures when the markets were in a downtrend.

What we do know is that the fund was short $24.8 million in notional value of S&P 500 futures against a portfolio NAV of $31.5 million or 79% as of April 30, 2022, so likely a large part of the 2022 outperformance was due to hedging (Figure 7).

When Does It Hedge?

Furthermore, going through the fund's literature and prospectus, it is unclear the triggers for when the fund will hedge market exposure via S&P 500 futures. At what market valuation multiples does the manager consider stocks overvalued and start to hedge exposure? What is the manager's definition of a downtrend?

Without knowing these important details, it is difficult to analyze and determine how much of the 2016-2020 underperformance was due to the fund hedging pre-maturely, and how much was due to the conflicting macro factors of 'Value' vs. 'Momentum'.

Conclusion

Overall, while I am impressed by the fund's outperformance in 2021 and 2022, I am concerned that the two factors chosen by the fund, 'Value' and 'Momentum', have historically worked counter to each other. When they work counter to each other, investors may be left with a mediocre portfolio of underperformers. I am also concerned that there is no clear definition of when the fund will hedge market exposure with regards to valuation and trend. Without knowing these details, it is difficult to analyze the strategy's massive underperformance from 2016 to 2020. I advise avoiding this complicated fund.