ITOT: A Solid Core Holding For Building An Efficient Portfolio

By | October 28, 2015

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Summary This ETF has a low expense ratio and looks like a solid option for a core position. As a total market ETF there is very little opportunity to modify exposures. Due to the sector allocations I believe the fund is best utilized when combining it with a small position in more specialized ETFs to tailor the sector allocations. Investors should be seeking to improve their risk adjusted returns. I’m a big fan of using ETFs to achieve the risk adjusted returns relative to the portfolios that a normal investor can generate for themselves after trading costs. One of the funds that I’m researching is the iShares Core S&P Total U.S. Stock Market ETF (NYSEARCA: ITOT ). I’ll be performing a substantial portion of my analysis along the lines of modern portfolio theory, so my goal is to find ways to minimize costs while achieving diversification to reduce my risk level. Expense Ratio The expense ratio for ITOT is only .07%. I tend to be very frugal with my expense ratios, so I like to see those low levels. There are a couple lower expense ratio ETFs in the categories of broad or total market, but .07% is still pretty good. Depending on where an investor does their brokerage, they may have incentives to use different ETFs to mitigate trading fees. Largest Holdings The following chart shows the largest holdings for the fund: These shouldn’t be a surprise since this is a total market ETF. The holdings across most total market ETFs will be very similar which gives investors a good reason to watch for high expense ratios, bid-ask spreads, and trading commissions to determine their long term costs. These allocations are subject to change, but I wouldn’t expect much in the way of change. Given the presence of such strong dividend champions at the top of the chart, investors might expect a strong dividend yield. Instead, they’ll find the yield is only around 2%. That’s no problem for most investors that would just reinvest their dividends anyway, but it may be less than optimal for investors in retirement seeking stronger yields to provide income without selling shares. Sectors The following chart breaks down the allocation by sector: The only sector I’ve been generally opposed to over the last several months has been telecommunications due to the aggressive price wars being waged. In this case the telecommunications allocation is just over 2.14%. In my view, that is a positive factor because 2.14% is a fairly low allocation for telecommunications among domestic equity ETFs. Using the holdings chart above, we can also determine that AT&T (NYSE: T ) and Verizon (NYSE: VZ ) combined to be about 1.92% of the portfolio, so most of the telecommunications allocation is right there. Energy Energy can be a fairly tricky sector because it can be referring to established champions like Exxon Mobil (NYSE: XOM ) or it can be referring to massively more aggressive plays such as off shore oil drilling. I like the fundamental premise of owning enormous producers of oil. If oil ever becomes irrelevant, it would be a very bullish sign for the rest of the economy pointing towards very low cost transportation and more capital available for spending on other goods and services. In order to hedge that risk, I want to see some of the established oil companies in the ETFs I use in my personal portfolios. I really wouldn’t mind seeing a higher allocation here so long as it was those established champions. They don’t have anywhere near as much upside as buying those drilling operations, but I am happy to sacrifice the upside to have dramatically reduced downside. Information Technology I know this is a growing part of our economy and it may continue to grow dramatically because information technology firms will generally have access to great economies of scale. I want some exposure to this part of the economy, but I wouldn’t mind seeing a slightly lower allocation because with great economies of scale comes the opportunity for earnings to get punished by a large drawdown in the economy or a black swan event. By definition, we won’t be able to predict black swans. However, I do believe we can estimate which industries have more exposure to those events. One Other Note There are 1509 holdings in this fund and it tracks the S&P Composite 1500 index. In my opinion a fund holding 1500 individual securities and tracking an index of 1500 securities is a broad market ETF, not a total market ETF. In my view any domestic ETF with fewer than 2000 holdings looks more like a broad market ETF than a total market ETF. Conclusion Overall this looks like a fairly good ETF. Since the ETF is going for a very low expense ratio and a passive style, there is not much to be done about adjusting the allocations. My preferred way to use an ETF like this would be to combine it with another more specialized ETF that placed a very high emphasis on my preferred sectors. When the investor combines the iShares Core S&P Total U.S. Stock Market ETF with another domestic equity fund they can look at the weighted average of the sector allocations which would be nice for building a very efficient portfolio. Scalper1 News

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