Shining The Transparency Light On ETFs

May 18, 2017

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article is by Mike Venuto, co-founder and chief investment officer of New York-based Toroso Investments.

Taking advantage of one of the greatest benefits of ETFs—transparency—can lead to some surprising discoveries. Case in point: the world of small-cap ETFs.

We’ve discovered that while a number of ETFs call themselves “small-caps,” they really don't have that much small-cap exposure. And that matters, because a fund that isn’t exactly small-cap is going to deliver different risks and different returns than a pure small-cap strategy.

Clarifying Terms

To be clear, at Toroso, we define small-caps as those having less than $2 billion in market capitalization, which appears to be the most common independent definition. It's not that anyone else is wrong about what constitutes a small-cap stock or a small-cap ETF, it’s just that others may be defining it differently.

With that in mind, let’s take advantage of the transparency of ETFs, dig a little bit deeper and look into the entire Vanguard lineup to see what we can learn.

Back in 2013, when we first examined the characteristics of small-cap ETFs, we pointed out that the Vanguard Small-Cap ETF (VB), which is based on the CRSP US Small Cap Index, had only about 35% small-caps.

Today VB has even less than that—21.8% small-caps. Compare that to the 64% small-caps in the iShares Core S&P Small Cap ETF (IJR), which uses the S&P SmallCap 600 Index, and it’s clear that this can really matter.

In the world of active management, this differentiation is often called “mission drift,” and can be the source of significant dispersion. A byproduct of ETF asset growth appears to be a passive form of mission drift, which is easy to monitor when you embrace the transparency of ETFs.

Looking Under The Vanguard Hood         

So let’s look at Vanguard’s lineup, with a view of taking measure of the overlaps between different size categories—both in terms of percentages and actual positions. I want to achieve a few things here:

  • We're going to hone in on a few of those overlapping positions and see how it affects the fundamentals of those specific securities or positions.
  • We also discovered a “value factor” bias that resides in some of these ETFs that I want to discuss.
  • We're further going to compare the value and growth approaches of the CRSP indices Vanguard uses with those of S&P indices, which underlie widely held ETFs from both iShares and State Street Global Advisors
  • Finally, I want to discuss whether these things can all be combined, and how those combinations affect overall asset allocation approaches.

So let's dive right into it. The chart below shows a slew of ETFs from Vanguard: a mega-cap fund as well as the value and growth versions of mega caps; the Vanguard large-cap fund as well as the value and growth versions; the midcap ETF and value and growth versions of midcaps; and the small-cap ETF VB and the value and growth versions of VB. 

% Overlap by Position Weights 

Source:, as of April 30, 2017


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