As investors navigate an environment of elevated equity concentration, the impact is being felt across value and growth strategies. Michael Mack, Client Portfolio Manager at Victory Capital sat down with ETF.com's Sumit Roy while at the ETF Oasis at Future Proof to talk quality investing, free cash flow, and the VictoryShares Free Cash Flow ETF (VFLO) . The following is a transcript of their conversation.
Free Cash Flow in a Time of Concentration
Sumit Roy:Hey, Michael. How are you doing?
Michael Mack:Great. Thanks for having me.
Sumit Roy:Hope you're enjoying the conference.
Michael Mack:It's nice. A little hot, but once the sun cools down it'll be perfect.
Sumit Roy:Absolutely. So I want to talk about concentration in the market. Michael, correct me if I'm wrong, you take issue with a lot of people considering a cap weighted benchmark as this neutral version of what the market is.
Michael Mack:That's right. What we're seeing is that, in the last ten years, the concentration in the market has grown, driven by things like the Mag Seven. And what we're finding is not only that they're showing up not just in growth portfolios, but in value portfolios as well. The default has been to lean on market cap weighted, and you end up with cases where you get some counterintuitive results. We've seen Tesla show up in value indexes. We've even seen SpaceX show up in a value ETF or two. And really part of that is by design, the way they are designed, where they need to capture all the market, and value and growth are really just split in half. Versus what we think investors should think about is indexes that can be more selective, that can look for desirable attributes and focus on those.
Sumit Roy:So why don't we talk about that? Basically, you're saying that with the traditional cap weighted indexes, investors are kind of chasing what's hot. Is that a fair way to put it?
Michael Mack:It is. If you take the old Rob Arnott idea of breaking the link between price and weight. With cap weighted, the higher your price goes, the more weight you get in an index, and vice versa: the lower your price goes, the less weight. So it exacerbates momentum in the market. And it has the counterintuitive effect at the turning points: you are going to be caught weighting based on what's happened in the past versus what's more likely to happen in the future.
Sumit Roy:And this seems like the extreme end of it, right? Because the biggest companies are as big as we've ever seen them. So that concentration is almost the biggest it's ever been in history.
Michael Mack:Exactly. And it's actually having asset allocation implications for investors as well. Because for people who follow things like the Morningstar Style Box, they're designed to take a percentage of market cap. Well, the bigger the percentage these top ten companies occupy, the fewer names actually qualify for inclusion in large cap. So we're seeing some definitions of large cap get closer to 100 names, and everything else is getting pushed to mid cap. So it's been tough for asset allocators to decide what's what. And it's all driven by market concentration. And it's a problem that we don't see an end to.
Sumit Roy:So given all this context, what should investors be looking at instead if they're not going to be looking at size?
Michael Mack:Yeah, we think quality is important. And one way we like to define quality is free cash flow. And it actually has two applications. It has an application on the value side: free cash flow to enterprise value, identifying companies that are attractively valued relative to their cash flows, where oftentimes sentiment creates opportunity. And then on the growth side, we've looked at a factor called free cash flow return on invested capital. It's a mouthful, a lot of letters. It's become super important in today's market. If you think of some of the hyperscalers that have come out and reported earnings, two of the factors: their CapEx is lowering cash flows, and secondarily, the market is now questioning the ROI on that CapEx. And that is directly what free cash flow return on capital tends to solve for. And if you think about it, we're trying to coin a new term. I don't think anyone's come out with it, but we'll see: equity vigilantes.
Sumit Roy:That's interesting.
Michael Mack:Yeah. We've seen the bond vigilantes from the 90s, where the bond market, if they didn't like deficits, they kind of forced governments to pare it back. We're seeing it on the equity side with CapEx, where the market is saying, hey, the bond markets are already saying we don't want to fund any more CapEx. So now some of these companies that hadn't issued stock in 25 years are now going to the market, and the equity market doesn't like it. And that is a function of not having a high enough return on capital relative to your growth rate. And so it's important that a company is able to generate high enough returns to fund their growth internally, versus having to go to the market.
Sumit Roy:I do love equity vigilantes. I like that one. So everything you talked about with regard to free cash flows, is this essentially the idea behind your ETF, the VictoryShares Free Cash Flow ETF, VFLO?
Michael Mack:That's right. And it's really, number one, it's trying to address the disconnect in the industry. Most value indexes lean on measures like price-to-book. You have 150 years of data, academic research. But in 2026 it's increasingly hard to value a company based on their book value, because a lot of companies' assets are intangible. So we're trying to focus on free cash flow. And by the way, when I say "we," these are rules based indexes that are targeting a factor exposure. In this case we're targeting free cash flow over enterprise value to identify a value portfolio.
A couple of things that we think make that product unique: number one, it's forward looking in nature. It doesn't just look backwards at a company's trailing cash flows, it also looks forward, using the consensus estimates, two years of data instead of one. That was helpful at the beginning of the year with a couple of AI infrastructure names. One was a slow growth PC maker last year; they came out and said, hey, we're now a fast growth AI server business. Having that forward look allows you to pick up on those names, taking into account their guidance. Whereas if you're just using trailing, you're always going to be 12 months behind the curve.
So that's the first differentiator. And then the second is, once the index has identified a value universe, then apply a growth filter, where you simply try to remove the slowest growers that have the potential to be value traps. So telecom companies, cable companies, consumer staples: cheap, and cheap for a reason. And so eliminating the slow growers, we think, can produce a more consistent outcome over time, but then also without sacrificing growth. So growth only comes after you've identified your high free cash flow yield value names. And so that's the goal with that.
Sumit Roy:So VFLO, and this ETF has been around for about three years, is that right?
Michael Mack:That's right. June of 23 was the launch of the large value one.
Sumit Roy:Well, Michael, a ton of great information. Thanks so much for your time.
Michael Mack:Thanks for having me. Appreciate it.
Disclosures
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All investing involves risk, including the potential loss of principal.The Fund has the same risks as the underlying securities traded on the exchange throughout the day. ETFs may trade at a premium or discount to their net asset value. The market prices of securities may go up or down, sometimes rapidly or unpredictably, due to general market conditions, such as real or perceived adverse economic, political, or regulatory conditions, recessions, inflation, or changes in interest or currency rates. Investing in companies with high free cash flowscould lead to underperformance when such investments are unpopular or during periods of industry disruptions. The Fund could also be affected by company-specific factors that could jeopardize the generation of free cash flow. Index Fundsinvest in securities included in, or representative of securities included in, the Index, regardless of their investment merits. The performance of the Fund may diverge from that of the Index. Large shareholders, including other funds advised by the Adviser, may own a substantial amount of the Fund's shares. The actions of large shareholders, including large inflows or outflows of cash, may adversely affect other shareholders, including potentially increasing capital gains.
Investments concentrated in an industryor group of industries may face more risks and exhibit higher volatility than investments that are more broadly diversified over industries or sectors. Investments in companies in the energy sectormay be subject to substantial government regulation, as well as risks involving changes in energy prices, international political instability, and liability for environmental damage and accidents resulting in loss of life or property. The profitability of companies in the healthcare sectormay be affected by government regulations and healthcare programs, fluctuations in the cost of, and demand for, medical products and services and product liability claims. Derivativesmay not work as intended and may result in losses. The Fund may frequently change its holdings, resulting in higher fees, lower returns, and more capital gains. The value of your investment is also subject to geopolitical risks such as wars, terrorism, trade disputes, environmental disasters, and public health crises; the risk of technology malfunctions or disruptions; and the responses to such events by governments and/or individual companies.
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The Victory U.S. Large Cap Free Cash Flow Indexaims to select high-quality companies from its starting universe by applying profitability screens. It then selects companies with the strongest free cash flow yield that exhibit higher growth. The Index is rebalanced and reconstituted quarterly. This Index calculates free cash flow yield by dividing expected free cash flow by enterprise value. Expected free cash flow is the average of trailing 12-month FCF and next 12-month forward free cash flow. Enterprise value (EV) measures a company's total value, often used as a more comprehensive alternative to equity market capitalization.
Free cash flowis the remaining cash a company has after covering all expenses. It can be used to invest in growing the business, pay dividends or pay down debt. Free cash flow yieldis the ratio of a company's free cash flow per share to its current EV. Forward P/Eindicates how much investors are paying today for every dollar of earnings expected over the next year. A higher number means the market is pricing in strong future growth; a lower numbersuggests modest growth expectations, or a potentially cheap stock. CapEx, or Capital Expenditure, refers to funds a company spends to acquire, maintain, or upgrade long-term physical assets that provide benefits over more than one year. Return on Investment (ROI)is a performance metric that measures the profitability of an investment by comparing the gain (or loss) to the initial cost, expressed as a percentage
The Magnificent Seven (Mag 7) consists of Alphabet (GOOGL; GOOG), Amazon (AMZN), Apple (AAPL), Meta Platforms (META), Microsoft (MSFT), NVIDIA (NVDA), and Tesla (TSLA).
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