Tag Archives: ideas

Summary The highest dividend yield comes from IWN, but the lowest expense ratio comes from IWM. The sector allocations for IWN and IWO add up to the same allocations as IWM. Between IWN and IWO, I don’t see IWO as being substantially more aggressive despite being based on a growth index. There is a rare situation where an investor could benefit from combining the value and growth funds rather than using the main fund. One of the areas I frequently cover is ETFs. I’ve been a large proponent of investors holding the core of their portfolio in high quality ETFs with very low expense ratios. The same argument can be made for passive mutual funds with very low expense ratios, though there are fewer of those. In this argument I’m doing a quick comparison of several of the ETFs I have covered. Ticker Name Index IWM iShares Russell 2000 ETF Russell 2000 Index IWN iShares Russell 2000 Value ETF Russell 2000 Value Index IWO iShares Russell 2000 Growth ETF Russell 2000 Growth Index By covering a few of these ETFs in the same article I hope to provide some clarity on the relative attractiveness of the ETFs. One reason investors may struggle to reconcile positions is that investments must be compared on a relative basis and the market is constantly changing which will increase and decrease the relative attractiveness. Dividend Yields I charted the dividend yields from Yahoo Finance for each portfolio. All else equal, I consider higher dividend yields to be more favorable even if the expectation for total returns is the same. The preference for higher yielding ETFs comes from behavioral finance rather than modern portfolio theory. Under behavioral finance the human elements of investing are considered. A higher yield can encourage investors to stay invested when the market is done and to recognize lower prices as an opportunity to acquire shares that are “on sale” rather than a reason to panic and sell their portfolio at low prices only to repurchase the securities at higher prices. Expense Ratios I want diversification, I want stability, and I don’t want to pay for them. My general guideline for expense ratios is that I want to see the ratios below .15% on domestic equity ETFs and below .30% on international equity ETFs. However, there are times where it is reasonable to make an exception. Funds that must regularly rebalance their portfolio have a better case for having a high expense ratio than funds that simply follow a market capitalization approach. Sector I built a fairly nice table for comparing the sector allocations across each ETF to make it substantially easier to get a quick feel for the risk factors: (click to enlarge) For an investor with an emphasis on certain sectors there could be an incentive to take either the growth or value side. I find the health care sector to be a fairly defensive allocation, but it is heavily over weight in the growth fund and underweighted in the value fund. The other major defensive allocations are consumer defensive, which is similarly weighted, utilities, which is heavier in value, and real estate which is heavier in value. All things considered, I don’t find the growth ETF to be substantially more aggressive than the value ETF despite the growth ETF being characterized by funds with higher expected earnings growth rates and higher price to book ratios. Would You Ever Want to Combine IWO and IWN? IWM represents the entire Russell 2000 index and the weightings for IWM are consistently within a very small rounding error of the weightings for the other two funds because of the way the value and growth indexes are constructed. Because of the way the funds are constructed, I would expect IWM to consistently outperform a position of IWN and IWO since the investor would save on the expense ratios by paying .20% on their position rather than paying .25% on each of the other funds. On the other hand, theoretically if the funds were trading at a small discount or premium to NAV there could be a reason to take the two smaller funds. Returns I thought it would be interesting to run the returns on all 3 ETFs and see how similar or different the performance was across the ETFs. The results surprised me. Over the last 15 years or so the value side of the index performed dramatically better. Given the dot com crash early in the century, the results may be heavily biased. (click to enlarge) I entered the ETFs with the growth ETF first, the blended ETF second, and the value ETF third. It is interesting to note that the beta and annualized volatility moves down as we shift from growth towards value. That fits what I would expect, but it is interesting to see that the lower risk position (using beta) materially outperformed. However, when we restrict the performance to the last five years, the picture for returns changes: (click to enlarge) Despite the growth ETF offering superior returns over the last 5 years, it has still demonstrated a higher beta and higher volatility. Therefore, I would expect the higher level of volatility and beta on IWO to remain as a simple function of investing in small capitalization growth companies. Conclusion Over the last 15 years there was a strong outperformance by the value side of the index. Despite the strong performance of the value side through a period that saw two market crashes, the value side of the index does not look dramatically safer. The beta values indicate that the risk level on the growth side of the index is around 8% to 10% higher than the value side. In my opinion, the most attractive option for long term investments would be IWM for the lower expense ratio of IWN for the lower beta since I hold a substantial position in larger capitalization domestic equity.