Parsing Size & Style
June 06, 2012
When looking for the right growth fund, it’s easy to just focus on the growth factors used to select growth stocks.
But growth factors don’t tell the whole story.
The graph below shows four major U.S. large-cap growth ETFs over the past year: the SPDR S&P 500 Growth ETF (NYSEArca: SPYG), Vanguard Russell 1000 Growth ETF (NYSEArca: VONG), iShares Russell Top 200 Growth Index Fund (NYSEArca: IWY) and Vanguard Mega Cap 300 Growth ETF (NYSEArca: MGK).
There’s a 4.1 percentage point difference between the top performer, IWY, and the bottom, VONG.
Some of this difference is driven by slightly different growth factors; for example, VONG looks at book-to-price ratios, medium-term growth forecasts and historical sales-per-share growth, while IWY only uses the latter two factors.
A lot of it, however, is driven by the very different “large-cap” indexes that they choose their securities from. IWY chooses growth stocks from the Russell Top 200 Index which, as the name implies, comprises the 200 biggest U.S. equities by market value.
In contrast, VONG draws growth stocks from the Russell 1000, which holds the 1,000 biggest U.S. equities. That means that its “large-cap growth” holdings actually include a lot of mid- and small-cap growth holdings, and these mid- and small-cap holdings behave differently than their larger brethren.
Does it make a difference? Yes.
Let’s look at the parent indexes. The graph below shows the SPDR S&P 500 ETF (NYSEArca: SPY), Vanguard Russell 1000 ETF (NYSEArca: VONE), iShares Russell Top 200 Index Fund (NYSEArca: IWL) and Vanguard Mega Cap 300 ETF (NYSEArca: MGC).
This graph, unsurprisingly, looks a lot like the large-cap growth ETF above it. Here, IWL beats VONE by about 2.4 percentage points, with the other two ETFs in the middle.
Over the past years, large companies have outperformed small, which is captured by both the broad large-cap funds and the growth-focused ETFs that are based upon them.
Now, with all that said, there can be very significant differences between growth ETFs that are based upon the same parent index.
The graph below shows the performance of three growth ETFs that are all based on the S&P 500: the SPDR S&P 500 Growth ETF (NYSEArca: SPYG), Guggenheim S&P 500 Pure Growth ETF (NYSEArca: RPG) and the First Trust Large Cap Growth AlphaDex ETF (NYSEArca: FTC).
As you can see, the difference between SPYG—the top performer over the past year—and the other two growth ETFs is huge. SPYG returned 4.6 percent over the past year, while RPG and FTC lost 2.3 percent and 6.6 percent, respectively.
There are a few reasons for this large disparity, and they don’t include wildly different growth factors.
In fact, SPYG and RPG use the same exact factors to determine growth stocks.
The major difference between the two is that SPYG includes the “core” stocks that are often considered to be between growth and value, while Guggenheim’s RPG focuses on “pure” growth and excludes core stocks. RPG also weights its constituents by their growth scores, rather than their market values, as SPYG does—this alternate weighting scheme tilts it toward smaller companies.
First Trust’s FTC starts with SPYG’s S&P 500 Growth Index and keeps the companies that get the highest growth scores, as determined by its own model. It then weights constituents in tiers based upon their scores.
The decision whether to include core stocks is a huge one, as is the choice of weighting scheme. You don’t need to look any further than SPYG vs. RPG to see that that’s true.
But size also plays a significant role and needs to be taken into consideration when placing your style bets. All large-cap (or midcap, or small-cap) indexes are not created equal.