The debate over fundamentally weighted indexes has become a common topic of discussion in indexing circles. Detractors of the theory argue that it results in indexes with a small-cap value tilt, and as of December 31, they can now point to 2007 as proof. In the year that large-cap and growth outperformed small-cap and value, fundamentally weighted indexes did not fare so well in comparison with cap-weighted indexes. In particular, dividend-weighted strategies seem to have been hit the hardest on the domestic front; the Dow Jones U.S. Select Dividend Index, for example, was down 5.16% in 2007, while the S&P 500 was up 5.49%. That's a difference in performance of nearly 1,000 basis points.
In this comparison, we examine large-cap and small-cap domestic ETFs as well as international ones from WisdomTree and PowerShares in comparison with other cap-weighted ETFs.
Amongst large-cap funds in 2007, the SPDRS (AMEX: SPY) and the iShares S&P 500 Index Fund (NYSE Arca: IVV) were up 5.40% and 5.44%, respectively. Meanwhile the Vanguard Large-Cap ETF (AMEX: VV), which tracks the MSCI U.S. Prime Market 750 Index, was up an even higher 6.44%, with ETFs based on other major cap-weighted indexes in between. However, the PowerShares RAFI U.S. 1000 Portfolio (NYSE Arca: PRF) was up just 4.25%, while the WisdomTree LargeCap Dividend Fund (NYSE Arca: DLN) was up 2.99%. The group was trailed by the WisdomTree High-Yielding Equity Fund (NYSE Arca: DHS), which actually declined 4.42%.
|Name||Ticker||2007 Return (%)|
|Vanguard Large Cap||VV||6.44|
|SPDR DJ Large Cap||ELR||6.19|
|iShares S&P 100||OEF||5.93|
|iShares Russell 1000||IWB||5.68|
|iShares S&P 500||IVV||5.44|
|SPDRs (S&P 500)||SPY||5.4|
|PowerShares FTSE RAFI 1000||PRF||4.25|
|WisdomTree LargeCap Div||DLN||2.99|
|WisdomTree Total Dividend||DTD||1.33|
|WisdomTree Div Top 100||DTN||0.11|
|WisdomTree High-Yld Eqty||DHS||-4.42|
Fundamental indexing also fared poorly in the small-cap domestic segment. Small-cap stocks did poorly, so it's no surprise that the best-performing fund, the SPDR Dow Jones Wilshire Small Cap ETF (AMEX: DSC), was up just 1.67% for the year. At the other end of the spectrum of cap-weighted funds, the iShares Russell 2000 Index Fund (NYSE Arca: IWM) was down 1.47%. In between that range fell the PowerShares FTSE RAFI U.S. 1500 Small-Mid Portfolio (NASDAQ: PRFZ), which was down 0.11%; it also outperformed the iShares S&P SmallCap 600 Index Fund (NYSE Arca: IJR), which was down 0.44%. The WisdomTree SmallCap Dividend Fund (NYSE Arca: DES), however, showed a rather stunning 12.05% decline.
|Name||Ticker||2007 Return (%)|
|SPDR DJ Small Cap||DSC||1.67|
|Vanguard Small Cap||VB||1.27|
|PowerShares FTSE RAFI1500||PRFZ||-0.11|
|iShares S&P 600 Small||IJR||-0.44|
|iShares Russell 2000||IWM||-1.47|
|WisdomTree SmallCap Div||DES||-12.5|
The WisdomTree MidCap Dividend Fund (NYSE Arca: DON) showed similarly poor performance in relation to other mid-cap funds, falling 5.49% while the MidCap SPDRs (AMEX: MDY) were up 8.25% and iShares S&P MidCap 400 Value Fund (NYSE Arca: IJJ) was up 2.42%. There is no similar PowerShares ETF that has a trading history for all of 2007.
"It's been what we call a perfect storm against value stocks concentrated in the financial arena," says WisdomTree President & Chief Operating Officer Bruce Lavine. Large-cap in particular was a very difficult environment, with large-caps outperforming small-caps and technology stocks—which are less likely to pay dividends—outperforming financial stocks, he adds. From that perspective, DLN underperformed only by a small margin—just a couple hundred basis points.
Lavine chalks much of the U.S. underperformance up to the subprime crisis and its aftereffects, with companies that had strong fundamentals often being hit the hardest. "There are some unique characteristics about the U.S. market that have just been tough this year. That had to do with getting let down by companies that had solid fundamentals on paper."