There's a saying that "Everything's Better in Texas."
With that in mind, let's take a look at the latest exchange-traded fund launch from San Antonio-based Victory Capital. The firm has roughly $155 billion in assets under management through a number of products including mutual funds, separately managed accounts (SMAs), and a 529 Education Savings Plan offering, among others. About $7.5 billion of that total can be attributed to the firm's ETF lineup of 24 funds. Let's look at Victory's latest addition, the Victory Shares Free Cash Flow ETF (VFLO) .
Hang Ten Investing
I've always said that investing is kind of like surfing. Day traders remind me of the skim-board folks that expend a lot of energy to propel themselves for short bursts right at the water's edge. Average surfers/investors sit out at a relatively close break point and catch whatever wave they can. Sometimes a particular wave can get crowded and not every surfer is successful in riding it in, let alone catching it. Then you've got the big wave surfers/hedge funds, the Laird Hamiltons of investing, the ones with the tools, knowledge, and experience to catch truly monster waves in places regular surfers don't even know about, and enthusiasts can only dream of going. Finally, although technically not surfers are those folks who are content to just sit in their boats and move up and down with the tides. These are, of course, the index investors of the world.
Cash (flow) Is King
We have corners of the investing world that can get pretty gnarly both from a capital intensity and sophistication perspective, but at its core investing can be quite simple and straightforward. We have seen a whole industry develop over the past two decades or so around the idea of Smart Beta, which in many circles has been described as factor investing with a shinier wrapping. The premise here is there are any number of metrics that will help investors find companies that will outperform the broad market. Some of these models have upward of 80 to 100 variables or more. To be clear, there have been products that have produced some outsized returns, but only periodically.
If there is one metric that speaks to a company's success it is a company's ability to generate revenues and report as much of those revenues as possible in the form of cash flow from operations. Many would say that net profit is a better metric but for me, there are too many opportunities for company management to get creative from an accounting perspective between the top and bottom lines of financial statements to make decisions based solely on that figure.
The prospectus for VFLO spells out that the security selection process begins with index provider VettaFi's Russell 1000 clone, the VettaFi US Equity Large/Mid-Cap 1000 Index. From there, companies with "negative projected free cash flows and earnings are removed" along with financials and real estate investment trusts (REITs). Remaining companies are then ranked by their free cash flow (FCF) yields (FCF /enterprise value). The top 75 companies by FCF yield are then given a growth score based on metrics like sales and/or earnings trends. From that list, the top 50 names are selected for the final portfolio.
Those 50 names are weighted so that companies with high FCF and FCF yield have more weight in the portfolio with individual position weights capped at 4%. There are some sector-based limitations, which include the number of names in any given sector being limited to 45% of the total number of names in the index, or 22, and the overall weight of any sector "will not exceed 20% of the weighting of that sector" in the initial VettaFi index.
Wrap It Up
As with any new fund, I can't make any investment recommendations. That said, I do like this fund's approach to security selection as it sticks to some basic principles which should work throughout all stages of the economic cycle. The only thing I think is missing in the fund is the opportunity to use the ticker FCF but unfortunately, that ticker is being used by First Commonwealth Financial Corporation. As with the other new launches I cover, I'll add this to the watch list and follow up once VFLO has some history under its belt.
