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Thursday, October 07, 2021

Value ETF vs Growth ETF Pair Trade

By Century Financial in 'Investment Insights'

Value ETF vs Growth ETF Pair Trade
Value ETF vs Growth ETF Pair Trade

* Trading in financial market carries risk and can result in loss of capital.

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The product and investment ideas do not consider the risk profile and financial position of the recipient and may not be suitable for everyone. Trading in financial markets and use of margin involves a significant risk of loss, which can exceed deposits. Please read the complete disclaimer carefully.

Risks & Assumptions
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Past performance is not indicative of and does not guarantee future results. Please read the complete disclaimer carefully.
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Holding cost is subject to change impacting the trade either negatively or positively.
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Trading pairs is not a risk-free strategy. The difficulty comes when prices of the two securities move contrary to the positions taken resulting in losses. Thus, it is important to adhere to strict risk management rules when dealing with such adverse situations.
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Individual stocks in the index are subject to both weightage recalculation & recomposition risk. As a result, certain stocks may be added or removed from the index upon index recalculation. Consequently, the performance of the relative index may deviate.
Small Cap the Winner

The bulls found a place to hide amidst the recent sell off and settled for companies bearing less of the brunt. At a time when the markets navigated through an uncertain phase of rising oil prices, plans of liquidity taper by the US Federal Reserve and developments in China, markets began to slip. While other indices closed in red, small cap was relatively resilient to the turbulent scenario.

Value: A New Trend?

Value stocks have lagged growth stocks for that period, despite sharply outperforming between September 2020 and March 2021. History says value stocks should resume beating growth stocks from here. In the first two years of a recovery from a recession, value stocks tend to outpace growth by about 24 percentage points. Moreover, value names are currently priced cheaply when compared with growth stocks. The average price-to-book ratio for the value fund is currently 28 percent of that for the average stock in the growth fund, according to FactSet data.

Strategy: Long iShares Russell 2000 Value ETF (IWN) & Short iShares Russell 2000 Growth ETF (IWO)

The chart below depicts the 1-year ratio between the iShares Russell 2000 Value ETF and the iShares Russell 2000 Growth ETF. In line with fundamentals, the ratio has increased since February 2021, when inflation numbers started climbing and rake hike fear surfaced amongst masses. The ratio has surpassed the strong resistance level of 0.5475 and based on the sector components and inflation levels prevailing currently, the ratio is likely to touch higher levels.

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Ratio between IWN & IWO
Date: 5th October 2021
Source: Bloomberg

Moderna’s insiders have been selling their shares in batches that reaffirm the company’s overvaluation.

The iShares Russell 2000 Value ETF tracks the performance of Russell 2000 value index. The highest weightage in the index is of the Financial sector (comprising of over 25 percent of the index). The banking sector is set to benefit from rate hikes and tapering as the reduction of frontloading will cause long term interest rates to rise. The steeper yield curve may allow banks to borrow at cheaper rates and further lend at a higher rate of interest, thus increasing their spread.

On the contrary, the iShares Russell 2000 Growth ETF tracks the performance of Russell 2000 growth index. The Healthcare sector combined with the Technology sector comprise of approximately 50 percent of the small cap growth Index. The tech sector is at a disadvantage and will bear the biggest brunt of the rise in interest rates, which will eventually lead to the lower valuation of tech enterprises.

Value and cyclical sectors have given back some of their early-year outperformance in recent weeks, but as long as bond yields begin to rebound, value and cyclicals should outpace growth.

Risks and Assumptions for Back-tested trading strategies
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The risks and assumptions listed here are not intended to be an exhaustive summary of all the risks and assumptions involved.
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The strategy might suffer from look-ahead bias which occurs due to the use of information or data in a study or simulation that would not have been known or available during the period being analyzed. This can lead to inaccurate results in the study or simulation.
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Future price movements may not be exactly the same as the historical price movements and this could lead to variation in performance.
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Testing can sometimes lead to over-optimization. This is a condition where performance results are tuned so high to the past they are no longer as accurate in the future.
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The model assumes no slippages in trading. Slippage refers to the difference between the expected price of a trade and the price at which the trade is actually executed.
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Drawdowns in actual trading can be higher than the tested system and losses could be significant in the event of leverage.
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Unforeseen events can lead to variation in performance from the tested trading strategy.
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The tested result has been computed with price feeds available from Bloomberg.
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The testing environment has not considered transaction or any other costs.
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Trading indicators used for the purpose of testing has been provided by Bloomberg.
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The strategy might suffer from data mining fallacy, selection bias and backfill bias.

Data Source: Bloomberg
Data as of: 05/10/2021

Arun Leslie John
Chief Market Analyst

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