Is JP Morgan’s Active Value ETF (JAVA) Worth a Look?

Value: index

The value ETF space is quite hotly contested, with the majority of investor inflows going towards two types of value ETFs: index-based and smart-beta.

Index value ETFs typically track value indexes like S&P 500 Value or the CRSP US Large Cap Value Index, which implement additional screeners for low price-to-book, price-to-earnings, and price-to-sales ratios to name a new. These ETFs must rigidly adhere to their benchmarks at all times, changing out their portfolio whenever the underlying index undergoes a reconstitution. Popular examples include:

• Vanguard Value ETF (VTV) - CRSP US Large Cap Value Index.
• iShares S&P 500 Value ETF (IVE) – S&P 500 Value Index. 

Value: Smart Beta

Then we have smart-beta ETFs. These ETFs use their own proprietary set of screeners and weighting methodology to target value stocks. They don't track an index, but they aren't completely actively managed either. They tend to be more expensive than value index ETFs, but cheaper than true actively managed value ETFs. Thus, they can be thought of as a hybrid. Popular examples include:

• Dimensional U.S. Targeted Value ETF (DFAT) – screens for low price-to-book, price-to-cash-flow, price-to-earnings ratios, profitability, and momentum factors.
• Avantis U.S. Large Cap Value ETF (AVLV) – screens for value (adjusted price-to-book) and profitability (adjusted cash-from-operations-to-book-value) ratios.

Value: truly active

Truly active value ETFs like JAVA are a "black box". That is, the methodology behind the ETF's security selection process is basically a "secret sauce" – it’s not disclosed. If we look at JAVA's summary prospectus, it doesn't specify the exact metrics that JAVA identifies a "value" stock by:

"The adviser will invest in companies whose securities are, in the adviser’s opinion, undervalued when purchased, but which have the potential to increase the intrinsic value per share. The “intrinsic value” of a stock is an expression of what the adviser believes to be the stock’s true worth."

"The adviser employs a bottom-up approach to stock selection, constructing portfolios based on company fundamentals, quantitative screening, and proprietary fundamental analysis. The adviser’s analysis includes a review of proprietary data, information self-reported by companies, data from third-party vendors and internal fundamental research."

The keyword here is "proprietary" – a bet on JAVA delivering value exposure is a bet on the fund management team (pictured below) having the right expertise and knowledge to identify value stocks. 

As with most actively managed funds, risks to watch include possible style drift from the team or objective changing over time and higher portfolio turnover and expense ratio (0.44%).

How has JAVA performed? 

JAVA has a limited performance history, so take this backtest with a grain of salt. Historically, it has outperformed a passive value index ETF like VTV but underperformed a smart-beta value ETF like DFAT.

During this time, JAVA incurred similar volatility and drawdowns as VTV, but much higher returns. It also fell the least during the 2022 bear market. 

I'm not surprised. According to SPIVA, only 58.70% and 39.46% of actively managed U.S. large-cap value ETFs have underperformed the S&P 500 Value Index over trailing one- and three-year periods. This shows that actively managed value ETFs can shine over the short to medium term.

However, by 15 years the gap narrows immensely, with 79.13% of actively managed U.S. large-cap value ETFs underperforming S&P 500 Value Index. The culprit behind this is likely higher expense ratios that compound over time – consider how JAVA charges 0.44%, 11x that of VTV at 0.04%. 

Actively managed value: final thoughts

I think JAVA has so far proven itself to be a decent value ETF worth considering for those willing to pay a higher expense ratio for the chance of outperforming. Historically, it's been more resilient than a comparable value index ETF during poor market conditions. 

To summarize my thoughts on the active vs index debate, I'll end by rehashing the five key points I noted in an earlier article on passive vs active REIT ETFs:

1. Some actively managed value ETFs will always outperform their passive index counterparts net of fees, but most will underperform. 
2. As more and more time goes on, both the number of outperforming actively managed value ETFs and the degree to which these ETFs outperform will shrink. 
3. Actively managed value ETFs face many headwinds that passively managed index ETFs do not, such as higher expense ratios, greater portfolio turnover, and the risk of management style drift. 
4. Identifying which actively managed value ETFs will outperform ex-ante is highly difficult, if not possible for the average retail investor to do. 
5. Actively managed value may have a higher chance of outperforming passively managed index ETFs when market conditions are poor or volatile. 

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.