Value ETF Actively Managed by Artificial Intelligence Shines Amid Market Turmoil

November 18, 2022 EST

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.

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/

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

Investors should consider the investment objectives, risks, charges and expenses carefully before investing. For a prospectus or summary prospectus with this and other information about the Fund, please call 1-855-973-7880 or visit our website at www.qraftaietf.com. Read the prospectus or summary prospectus carefully before investing.

The Funds are distributed by Foreside Fund Services, LLC

Investing involves risk, including loss of principal. The Funds are subject to numerous risks including but not limited to: Equity Risk, Sector Risk, Large Cap Risk, Management Risk, and Trading Risk. The Funds rely heavily on a proprietary artificial intelligence selection model as well as data and information supplied by third parties that are utilized by such model. To the extent the model does not perform as designed or as intended, the Fund’s strategy may not be successfully implemented and the Funds may lose value. Additionally, the funds are non-diversified, which means that they may invest more of their assets in the securities of a single issuer or a smaller number of issuers than if they were a diversified fund. As a result, each Fund may be more exposed to the risks associated with and developments affecting an individual issuer or a smaller number of issuers than a fund that invests more widely. A new or smaller fund's performance may not represent how the fund is expected to or may perform in the long term if and when it becomes larger and has fully implemented its investment strategies. Read the prospectus for additional details regarding risks.

While it is anticipated that the Adviser will purchase and sell securities based on recommendations by the U.S. Large Cap Database, the Adviser has full discretion over investment decisions for the Fund. Therefore, the Adviser has full decisionmaking power not only if it identifies a potential technical issue or error with the U.S. Large Cap Database, but also if it believes that the recommended portfolio does not further the Fund’s investment objective or fails to take into account company events such as corporate actions, mergers and spin-offs.


QRAFT AI-Enhanced U.S. Large Cap ETF: Companies in the health care sector are subject to extensive government regulation and their profitability can be significantly affected by restrictions on government reimbursement for medical expenses, rising costs of medical products and services, pricing pressure (including price discounting), limited product lines and an increased emphasis on the delivery of health care through outpatient services.

QRAFT AI-Enhanced U.S. Large Cap Momentum ETF: The Fund is subject to the risk that market or economic factors impacting technology companies and companies that rely heavily on technology advances could have a major effect on the value of the Fund’s investments. The value of stocks of technology companies and companies that rely heavily on technology is particularly vulnerable to rapid changes in technology product cycles, rapid product obsolescence, the loss of patent, copyright and trademark protections, government regulation and competition, both domestically and internationally, including competition from foreign competitors with lower production costs. Technology companies and companies that rely heavily on technology, especially those of smaller, less-seasoned companies, tend to be more volatile than the overall market.

QRAFT AI-Enhanced US High Dividend ETF: Securities that pay dividends, as a group, may be out of favor with the market and underperform the overall equity market or stocks of companies that do not pay dividends. In addition, changes in the dividend policies of the companies held by the Fund or the capital resources available for such company’s dividend payments may adversely affect the Fund. In the event a company reduces or eliminates its dividend, the Fund may not only lose the dividend payout but the stock price of the company may also fall.

QRAFT AI-Enhanced U.S. Next Value ETF: The value approach to investing involves the risk that stocks may remain undervalued, undervaluation may become more severe, or perceived undervaluation may actually represent intrinsic value. Value stocks may underperform the overall equity market while the market concentrates on growth stocks. The small- and mid-capitalization companies in which the Fund invests may be more vulnerable to adverse business or economic evens than larger, more established companies, and may underperform other segments of the market or the equity market as a whole. Securities of small- and mid-capitalization companies generally trade in lower volumes, are often more vulnerable to market volatility, and are subject to greater and more unpredictable price changes than larger capitalization stocks or the stock market as a whole.

Alpha – Alpha is a measure of the active return on an investment, the performance of that investment compared with a suitable market index.

AutoML – Short for Automated Machine Learning, AutoML is the automation of the machine learning process to make machine learning jobs simpler, easier, and faster.

Kirin API - Developed by Qraft’s data scientists, integrates multiple vendors to provide both macroeconomic and company fundamentals with the correct point-in-time data.