Encouraging investors to maintain a diversified portfolio is challenging when one asset class has outperformed the others in recent years.
Many investors are hesitant to allocate to value, as many value strategies have lagged in recent history. While U.S. large cap growth stocks performed well during the past 12 months¹, current valuations are exceptionally high.
Long-term investors may be able to enhance returns by maintaining a well-diversified portfolio and incorporating the VictoryShares Free Cash Flow ETF (NASDAQ:VFLO). The fund works as a key tool to improve value exposure while complementing growth exposure.
See more: “Mythbusting in Finance: Unraveling Dividend Growth Misconceptions Among Advisors”
Maintain Exposure to Growth While Optimizing for All Environments
With over $244 billion in assets under management, the Invesco QQQ Trust (NASDAQ:QQQ), which tracks the Nasdaq 100 Index, is a favorite growth ETF among investors. The fund has returned nearly 40% in the past year but is also highly concentrated. Notably, the Magnificent Seven stocks comprise 40% of the fund by weight as of February 6, 2024 per ETF Database.
Historically, if a company managed to generate significant profits, competitors would come in, and then profits would slow, Mack said. The Magnificent Seven has managed to defy that. “They get bigger and continue to grow,” he added. “Up until the last decade, buying the top companies of any given sector has not worked out well for investors.”
While QQQ has generated attractive returns recently, investors should recognize that future performance is not guaranteed. Generally, performance across the market can be particularly volatile during periods of high valuations. High valuations in public companies, seen in metrics like the price-to-earnings (P/E) ratio, indicate investors are paying more for a company’s earnings, expecting future growth. This could mean that a company’s price is more than it is actually worth.
In 2022, when investors began getting wary of the high valuations underpinning U.S. large cap growth stocks, QQQ significantly underperformed the broader market, declining 33% during the year.
Why VFLO & QQQ Could Pair to Create an All-Weather Portfolio
History has shown that when investors get nervous about valuations, they tend to flock to companies with high free cash flow yields. “If they’re worried about the companies with high valuations, they’re going to gravitate towards the companies with low valuations,” Mack said.
Therefore, VFLO could work as a complement to QQQ in a portfolio. VFLO, which uses free cash flow as a metric, captures stocks trading at a discount (i.e., value stocks) with favorable growth prospects.
Looking back at 2022 when the growth-oriented Nasdaq-100 Index underperformed the market, the free cash flow yield segment performed well. QQQ and VFLO have tended to work in opposite directions. That potentially makes them a complementary pair, effectively creating what we believe is an all-weather portfolio.
“Having something on the value side and the growth side could potentially give you an all-weather portfolio,” Mack added. “Some years we could see the growth side win, and other years, the value side may win.”
For more news, information, and analysis, visit the Free Cash Flow Channel.
Article by Elle Caruso, ETF Trends
