Fans of the Russell 2000 Index may want to rethink their loyalty.
Small-cap indexes have trailed the S&P 500 Index this year, but in spite of the underperformance, investors should note that not all small-cap ETFs are created equal. Indeed, a comparison between the S&P 600 Index and the Russell 2000 Index shows that anyone hoping to maximize returns may want to choose funds carefully.
The year-to-date charts for small-cap indexes and related ETFs might not be pretty, but investors in the S&P 600 SmallCap Index are winning the “beauty” contest versus those who own products based on the Russell 2000 small cap benchmark, even over the arc of time.
So far this year, the Russell 2000 is up about 0.6 percent, while the S&P 600 has gained 1.5 percent through July 7. Over the past 12 months, the Russell 2000 has lagged the S&P 500 Index by a greater amount (16.6 percent versus 19 percent) and, taking it out on an even longer time horizon, the S&P 500 Index has gained 68 percent over the past five years, while the Russell index trailed at 55 percent.
Speaking to the underperformance of small-caps this year, Spencer Bogart, an ETF analyst at ETF.com, noted that since the stock market bottomed out on March 9, 2009, investors in the iShares S&P SmallCap 600 ETF (IJR | A-92) have enjoyed a 270 percent run-up versus 200 percent for the S&P 500, according to data from StockCharts.com.
“We would expect small-caps to outperform large-caps over the course of a bull run,” said Bogart. “That said, is that outperformance going to be smooth and consistent? No. Small-caps performed particularly well in the early stages of this recovery and, as we’ve gotten later in the bull market, large-caps have caught up a bit.”
ETFs that track the respective indexes tell the same tale. IJR is up 2.5 percent, versus the Vanguard Russell 2000 Index Fund (VTWO | A-83), which is up 1.8 percent year-to-date. Over the past 12 months, IJR has gained 20 percent versus 18 percent for VTWO.
Investors who have held on to IJR for the past three years have had a 52 percent gain versus a 43 percent gain for VTWO investors.
Chart cmourtesy of StockCharts.com
“IJR’s portfolio is much more small-cap-centric than VTWO’s,” said Bogart.
“In contrast, VTWO’s portfolio reaches both larger and smaller than IJR, as its 2,000 holdings include more mid- and micro-cap companies. Ultimately, the net effect of VTWO having more large companies and more small companies than IJR is a larger weighted average market cap,” he added.
Bogart noted that a side effect of VTWO’s broader portfolio is a growth tilt: VTWO’s inclusion of micro-caps boosts its portfolio price/earnings ratio to 83, while IJR sits significantly lower at 33. High-growth tech and biotech companies were whipsawed earlier in April as investors shunned riskier assets for safer, defensive plays in sectors such as utilities.
And because fees matter, the expense ratio on iShares’ IJR is 0.17 percent, or $17 for every $10,000 invested, versus 0.21 percent for Vanguard’s VTWO. Other ETFs that track the Russell and S&P indexes and their fees include:
- iShares Russell 2000 ETF (IWM | A-81), 0.24 percent, or $24 for every $10,000 invested
- Guggenheim Russell 2000 Equal Weight ETF (EWRS | B-73), 0.45 percent
- SPDR S&P 600 Small Cap ETF (SLY | A-93), 0.20 percent
- Vanguard S&P Small-Cap 600 ETF (VIOO | A-86), 0.17 percent
Perhaps more importantly for investors chasing returns is the fact that S&P screens its underlying companies to be profitable for the previous four quarters, whereas the Russell 2000 doesn’t.
“The screen excludes companies whose aggregate earnings over the past four quarters is negative,” according to Bogart. “This also serves to reduce IJR’s P/E ratio and give it less of a growth tilt than VTWO.”