PRF ETF: A Solid Smart Beta Fund, But There Are Cheaper Alternatives
The Invesco FTSE RAFI US 1000 ETF (NYSEARC:PRF) is a well-diversified smart beta fund suitable for investors who want a slight bias towards value stocks while maintaining broad market exposure. This article will demonstrate why its fundamentals are compelling, highlighted by a forward price-to-earnings ratio six points lower than the S&P 500. However, its high expense ratio of 0.39% means it should not be a core holding in your portfolio. Therefore, I remain neutral on PRF today and will provide you with a list of lower cost alternatives with similar functionality.
Presentation of the ETF
Fundamentals of Strategy and Funds
PRF tracks the FTSE RAFI US 1000 Index, selecting a thousand US-listed companies with the best RAFI fundamentals from across the NYSE and NASDAQ universe. The components are weighted using a set of fundamental factors, including:
- total cash dividends
- free movement of capital
- total sales
- net book value
Although the universe of stocks is large, it is still primarily a large-cap index due to these criteria. It stands to reason that the largest companies by market capitalization are the most likely to pay the largest cash dividends and generate the most free cash flow and sales. However, I still see it as a cross between a large-cap mix and a large-cap value ETF. The cash dividend screen gives it meager value, as 84% of voters pay a dividend. In other words, for the index to include a non-dividend payer, other fundamentals are likely to be very strong.
I scoured my database of US equity ETFs to find comparators that I believe are reasonable based on current fundamentals. They are:
- Schwab Fundamental US Large Company Index ETF (FNDX)
- Schwab Fundamental US Broad Market Index ETF (FNDB)
- Franklin LibertyQ US Equity ETF (FLQL)
All have lower expense ratios than PRF, as summarized by Morningstar below. I have included the SPDR S&P 500 ETF (SPY) for reference purposes only.
PRF has performed well since its launch on December 19, 2005, nearly matching the SPDR S&P 500 Index ETF (TO SPY) Return. Considering how the markets have favored growth for most of these 16+ years and the fact that the FRP expense ratio is 0.30% higher, I think these results are impressive.
Historically, PRF has been more volatile, characterized by worse Specimens, but stronger and faster recoveries. For example, PRF lost 55.67% during the Great Financial Crisis compared to 50.80% for SPY. However, PRF recovered these losses in 24 months compared to 37 months for SPY. If you’re considering using PRF for downside protection, keep this in mind, as these results suggest it’s not a good idea.
Sector exposures and top ten holdings
ETF sector exposures are shown below for each ETF. PRF is well diversified across industries, but so are Schwab’s products. PRF is overweight financials, while FNDX and FNDB are slightly more exposed to technology. FLQL is the outlier, overweighting both the healthcare and technology sectors.
PRF’s top ten holdings are below, led by Berkshire Hathaway (BRK.B). Others include Exxon Mobil (XOM), Apple (AAPL) and AT&T (J). Together, these ten companies only total 17.39%, reflecting the ETF’s strong diversification.
A perhaps more useful way would be to organize the PRF according to its top five holdings in each of its top 20 industries. The table below shows that stocks of diversified banks, integrated oil and gas, pharmaceuticals, electric utilities and integrated telecommunications services are significant holdings.
The chart below highlights some fundamental metrics for each of these 20 industries. I’ve also provided summary metrics for the four comparators mentioned earlier, which I hope will help you decide if PRF is right for you.
As noted, PRF is very similar to FNDX and FNDB in most areas, including:
- Concentration in the top 20 industries: 49.44% versus 52.20% and 50.14%
- Beta at five years: 1.01 versus 1.02 and 1.04
- Five-year annualized revenue growth: 7.80% vs. 7.43% and 7.45%
- Estimated year-on-year revenue growth: 10.39% vs. 11.13% and 11.26%
- Estimated year-on-year earnings growth: 16.41% vs. 17.37% and 17.53%
- One-year forward price/earnings ratio: 17.70 vs. 17.21 and 17.32
- In search of an alpha profitability rating: A- against A- and A-
Given this, I would recommend investors go for the lower-cost Schwab products, which have expense ratios of 0.25%. They also track RAFI indices, so I don’t think PRF fundamentally has a distinct advantage. A 0.14% reduction in annual expenses may not seem like much, but PRF shareholders will lose 5.68% of their total earnings in fees, compared to 3.66% for FNDX and FNDB, assuming a ten-year holding period. and an annual return of 10%. This gap widens as you increase your holding period, so keep this in mind if you plan to own a PRF for an extended period of time.
Compared to SPY, PRF has a nice valuation advantage, with a forward price/earnings ratio six points lower (17.70 vs. 23.53). However, this discount has some merit, given PRF’s lower growth potential. Notice how most of the major FRP industries have estimated single-digit revenue growth for the next year, and they’re also not as profitable as Seeking Alpha’s profitability ratings indicate (A- vs. A) . Additionally, if backtested, PRF’s current portfolio would return 89.41% over the past five years, compared to SPY’s 131.92%. Of course, past performance doesn’t predict future results, but investors seem willing to pay a small premium for good historical performance. Makes sense, but it will be interesting to see if this continues as market dynamics change.
Basically, FLQL looks superior. Its valuation sits roughly in the middle of PRF and SPY and does not give up any upside potential. Its constituents achieve an A+ Seeking Alpha Profitability Grade weighted average, have performed well over the past five years, and even had a slightly better last quarter as measured by revenue surprises. Despite these characteristics, I am not yet ready to return to the technology sector with two feet. While I think there are pockets of opportunity right now, especially in the semiconductor industry, I’m waiting for more evidence of a shift in sentiment.
PRF has been a reasonably impressive ETF since its inception in 2005, managing to keep pace with the more growth-oriented S&P 500 index, despite adopting a fundamental approach. I think it will continue to do well since it has a slight lean value and is well diversified. However, I encourage investors to seek out low-fee ETFs with similar characteristics. FNDX and FNDB are a good match in many areas, including concentration, volatility, valuation, and growth, and I think it’s more appropriate for long-term investors. Do not hesitate to read my opinion on FNDX hereand I look forward to answering all of your questions in the comments section below.