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VBK: The Benefits Of Small-Cap Growth Stocks

By Jonathan Jones and Tom Lydon Stock-picking is difficult and plenty of data support that assertion. It can be said that the task is even more difficult with smaller stocks, explaining why so many active managers of small-cap funds lag their benchmarks. Over the one-year period, mid- and small-cap growth funds were especially poor performers, according to industry analyst ETF Trends . For instance, only 20% of all mid-cap growth funds outperformed the S&P MidCap 400 Growth Index, and investors paid an average 1.3% fee on mid-cap growth funds for the that underperformance as well. In comparison, mid-cap ETFs have an average expense ratio of 0.42%, according to XTF data. “On an equal-weighted basis, the average mid-cap growth fund returned -1.23% and lagged by 328 basis points in 2015, much higher than the expense ratio incurred,” Rosenbluth said. “This suggests to us that unwarranted stock selections contributed to underperformance.” Additionally, just 12% of all small-cap growth funds outperformed the S&P SmallCap 600 Index. Funds that track larger companies fared slightly better, with 51% of all large-cap growth funds outperforming the S&P 500 Growth index. The Vanguard Small-Cap Growth ETF (NYSEArca: VBK ) is a cost-effective option for investors looking for a passive approach to small-cap growth stocks. Compared to an actively managed small-cap fund, VBK is cheap. Well, compared to almost any fund, VBK is cheap as it charges just 0.09% per year, or $9 for every $10,000 invested. That is less expensive than 93% of rival funds, according to Vanguard . The $3.9 billion ETF holds over 700 stocks, nearly 22% of which are financial services names. Industrials and technology stocks combine for over 34% of VBK’s weight. VBK follows the CRSP US Small Cap Growth Index. “CRSP classifies growth securities using the following factors: future long-term growth in earnings per share (EPS), future short-term growth in EPS, 3-year historical growth in EPS, 3-year historical growth in sales per share, current investment-to-assets ratio, and return on assets,” according to a Seeking Alpha analysis of VBK. Cyclical stocks, like materials, industrials, energy and technology companies, are more economically sensitive and do well when the economy is improving. With the Federal Reserve set to hike rates, the rising rate environment would signal a better economic outlook. Cyclical sectors, which are heavily represented in VBK, currently trade at a discount to the broader market. In addition to its large combined weight to industrial and technology stocks, consumer discretionary names command over 15.5% of VBK’s weight. Vanguard Small-Cap Growth ETF Click to enlarge Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Cheap Funds Dupe Investors – Q1 2016

Fund holdings affect fund performance more than fees or past performance. A cheap fund is not necessarily a good fund. A fund that has done well in the past is not likely to do well in the future ( e.g. 5-star kiss of death and active management has long history of underperformance ). Yet, traditional fund research focuses only on low fees and past performance. Our research on holdings enables investors to find funds with high quality holdings – AND – low fees. Investors are good at picking cheap funds. We want them to be better at picking funds with good stocks. Both are required to maximize success. We make this easy with our predictive fund ratings. A fund’s predictive rating is based on its holdings, its total costs, and how it ranks when compared to the rest of the 7000+ ETFs and mutual funds we cover. Figure 1 shows that 70% of fund assets are in ETFs and mutual funds with low costs but only 1% of assets are in ETFs and mutual funds with Attractive holdings. This discrepancy is astounding. Figure 1: Allocation of Fund Assets By Holdings Quality and By Costs Sources: New Constructs, LLC and company filings Two key shortcomings in the ETF and mutual fund industry cause this large discrepancy: A lack of research into the quality of holdings. A lack of high-quality holdings or good stocks. With about twice as many funds as stocks in the market, there simply are not enough good stocks to fill all the funds. These shortcomings are related. If investors had more insight into the quality of funds’ holdings, we think they would allocate a lot less money to funds with poor quality holdings. Many funds would cease to exist. Investors deserve research on the quality of stocks held by ETFs and mutual funds. Quality of holdings is the single most important factor in determining an ETF or mutual fund’s future performance. No matter how low the costs, if the ETF or mutual fund holds bad stocks, performance will be poor. Costs are easier to find but research on the quality of holdings is almost non-existent. Figure 2 shows investors are not putting enough money into ETFs and mutual funds with high-quality holdings. Only 78 out of 7421 (1% of assets) ETFs and mutual funds allocate a significant amount of value to quality holdings. 99% of assets are in funds that do not justify their costs and over charge investors for poor portfolio management. Figure 2: Distribution of ETFs & Mutual Funds (Count & Assets) By Portfolio Management Rating Click to enlarge Source: New Constructs, LLC and company filings Figure 3 shows that Investors successfully find low-cost funds. 70% of assets are held in ETFs and mutual funds that have Attractive-or-better rated total annual costs , our apples-to-apples measure of the all-in cost of investing in any given fund. Out of the 7421 ETFs and mutual funds we cover, 1664 (70%) earn an Attractive-or-better total annual costs rating. Clearly, ETF and mutual funds investors are smart shoppers when it comes to finding cheap investments. But cheap is not necessarily good. The Nationwide Portfolio Completion Fund (MUTF: NAAIX ) gets an overall predictive rating of Very Dangerous because no matter how low its fees (0.62%), we expect it to underperform because it holds too many Dangerous-or-worse rated stocks. Low fees cannot boost fund performance. Only good stocks can boost performance. Figure 3: Distribution of ETFs & Mutual Funds (Count & Assets) By Total Annual Costs Ratings Click to enlarge Source: New Constructs, LLC and company filings Investors should allocate their capital to funds with both high-quality holdings and low costs because those are the funds that offer investors the best performance potential. But they do not. Not even close. Figure 4 shows that less than half (49%) of ETF and mutual fund assets are allocated to funds with low costs and high-quality holdings according to our predictive fund ratings, which are based on the quality of holdings and the all-in costs to investors. Figure 4: Distribution of ETFs & Mutual Funds (Count & Assets) By Predictive Ratings Click to enlarge Source: New Constructs, LLC and company filings Investors deserve forward-looking ETF and mutual fund research that assesses both costs and quality of holdings. For example, the Market Vectors Semiconductor ETF (NYSEARCA: SMH ) has both low costs and quality holdings. Why is the most popular fund rating system based on backward-looking past performance? We do not know, but we do know that the transparency into the quality of portfolio management provides cover for the ETF and mutual fund industry to continue to over charge investors for poor portfolio management. How else could they get away with selling so many Dangerous-or-worse ETFs and mutual funds? John Bogle is correct – investors should not pay high fees for active portfolio management. His index funds have provided investors with many low-cost alternatives to actively managed funds. However, by focusing entirely on costs, he overlooks the primary driver of fund performance: the stocks held by funds. Investors also need to beware certain Index Label Myths . Research on the quality of portfolio management of funds empowers investors to make better investment decisions. Investors should no longer pay for poor portfolio management. D isclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, sector or theme. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Virtus Plans To Roll Out Actively Managed Japan ETF

Last month, Bank of Japan’s (BOJ) move to impose a negative interest rate for the first time in its history took the markets by surprise (read: Japan ETFs to Buy on Negative Interest Rates ). The BOJ’s step will help the third-largest country in the world to get closer to its target inflation rate of 2% by the first half of next year and boost confidence and spur demand. The BOJ Governor Haruhiko Kuroda stated that there is no limit to efforts for easing monetary policy. The central bank may further expand asset purchases if required (read: Japan ETFs to Tap on Renewed Stimulus Hopes ). Encouraged by this, Virtus has recently filed for an actively managed ETF, Virtus Japan Alpha ETF (EJA) , targeting this market. While a great deal of the key information, such as expense ratio, was not available in the initial release, other important points were released in the filing. We have highlighted those below for investors who may be looking for a fresh out-of-oven play targeting Japan from Virtus should it pass regulatory hurdles: Proposed Fund in Focus As per the SEC filing , the fund will generally comprise securities of Japanese companies listed on the JPX-Nikkei 400 Total Return Index. Japan Tobacco Inc. ( OTCPK:JAPAY ), Takeda Pharmaceutical Company Limited ( OTCPK:TKPYY ), Toyota Motor Corporation (NYSE: TM ) and Nippon Telegraph and Telephone Corporation (NYSE: NTT ) are some of the top weighted stocks in the index. The fund’s basket will include approximately 80-100 stocks from the Index based on quantitative and qualitative factors such as cash flow return on invested capital, earnings quality and momentum, operational quality, corporate governance policies and capital stewardship. The proposed ETF looks to provide long-term capital appreciation. Although Virtus ETF Advisers LLC is the fund’s adviser, it has appointed Euclid Advisors LLC as sub-adviser. The fund’s investments will be managed by Euclid Advisors. The issuer may exit from any stock, if it believes that the stock has become overvalued or if the stock’s weightage in the portfolio is too large. How does it fit in a portfolio? This proposed product could be an interesting choice for investors seeking exposure to the Japanese market. This is because the prime minister, Shinzo Abe, has started implementing his stimulus program, popularly known as Abenomics, in an effort to lift the economy out of feeble growth and deflationary pressure. Abenomics is a combination of aggressive quantitative easing policies from BOJ, increased public infrastructure spending and a boost to exports. In such a scenario, a Japan focus seems to be a good idea. As such, the fund might be a great choice in a global slowdown. The fund does offer some diversification benefit through exposure to Japan markets. The product uses a bottom-up approach and fundamental analysis ensures the fund includes stable and sound companies. Can it succeed? The proposed ETF does not have any direct competitor as there are currently no actively managed Japan ETFs available to U.S. investors. The proposed fund, if approved, could give investors a new way to play the Japanese equity market. The product might charge higher fees from investors annually due to its unique strategy. However, there are quite a number of other Japan equity ETFs listed in the U.S. Of these, the ultra-popular fund, iShares MSCI Japan ETF (NYSEARCA: EWJ ) , has a total asset base of $17.7 billion. This fund tracks the MSCI Japan Index and holds 318 stocks in its basket. It trades in heavy volume of 46 million shares per day and charges 47 bps in annual fees. EJA could also face competition from Japan hedged funds – the WisdomTree Japan Hedged Equity ETF (NYSEARCA: DXJ ) with an asset base of $10.6 billion, the db X-trackers MSCI Japan Hedged Equity ETF (NYSEARCA: DBJP ) with AUM of $1.1 billion and iShares Currency Hedged MSCI Japan ETF (NYSEARCA: HEWJ ) with AUM of $616.5 million. Thus, the proposed ETF, if launched, has a good chance of making a name for itself if it manages to generate returns net of fees greater than the passively managed products in the Japan equity ETF space. Virtus Japan Alpha ETF’s plan of using a bottom-up approach and fundamental analysis for stock selection is noteworthy, but its success is a huge factor of the returns it manages to generate. Link to the original post on Zacks.com Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.