Under The Hood Of Value And Growth ETFs

by on December 14, 2009 | ETFs Mentioned:

When discussing their portfolios and asset allocation tactics, many investors and advisors indicate their preference for either value and growth investing in an effort to define their general investment strategy. ETF investors are no different, with dozens of funds that tilt their holdings towards each strategy offering ways to construct portfolios designed to take advantage of various investment theses. But many value and growth ETFs don’t offer pure plays on these investment strategies, and a surprising number of stocks can be found in both types of funds.

Value vs. Growth

Value stocks generally have low price-to-earnings ratios and high dividend yields, while growth stocks generally have much higher earnings or revenue multiples and may not pay out any of their earnings (or may even have negative earnings). As stereotyped, value stocks are generally more established companies that may be at or near maturity, while growth companies are at a much earlier stage in their life cycle. Along with increased potential returns, growth stocks are generally believed to carry more risk. ETFdb Pro members can read more about value and growth funds in our ETFdb Category Reports (if you’re not a Pro member yet, sign up for a free trial or read more here).

The relative performance of value and growth investment strategies is a hotly-debated topic, with the investment community split between the two camps. Some prefer one style another universally, while others tend to gravitate towards value stocks in certain environments and growth equities in others. Several widely-read studies by well-respected authors seem to indicate that over time, value stocks have outperformed their growth counterparts.

Not everyone puts stock in the merits of traditional methodologies used to classify value and growth stocks. In his 2000 letter to shareholders, Warren Buffett expressed his belief that “market commentators and investment managers who glibly refer to growth and value styles as contrasting approaches to investment are displaying their ignorance, not their sophistication.” Buffett is one of the most successful value investors, but his investment strategy involves identifying companies trading at low price-to-intrinsic value ratios, as opposed to ratios of price to more readily identified metrics such as revenue, earnings, or cash flow.

Still, many investors swear by value and growth investing, preferring  to tilt their portfolios growth stocks in certain economic environments and towards value plays in others.

Overwhelming Overlaps…And Pure Play Alternatives

As the ETF industry has expended, a number of funds offering exposure to value and growth stocks have emerged, essentially investing in subsets of widely-followed benchmarks (e.g., the Russell 1000) that rank highest for certain defining metrics. But many popular value and growth benchmarks don’t exactly use a “one or the other” classification system when slotting individual stocks. In fact, far from it.

Style Overlap
ETFs Overlap* Correlation
IWF/IWD 53% 0.94
IWO/IWN 51% 0.95
*Reflects number of holdings

Of the 619 stocks held by the iShares Russell 1000 Growth Index Fund (IWF), 334, or 53%, are also included in the Russell 1000 Value ETF (IWD). The overlap among small cap stocks is similar: 51% of the 1,200+ components of the Russell 2000 Growth Index Fund (IWO) can also be found in the value counterpart (IWN). This results in surprisingly strong correlation between these ETFs – as high as 0.95% in the case of IWN and IWO.

Pure Style ETFs
ETFs Overlap Correlation
RPV/RPG 0% 0.81
RFG/RFV 0% 0.77
RZV/RZG 0% 0.76

But not all value and growth ETFs feature as much overlap as the Russell products from iShares. Rydex offers a series of “pure value” and “pure growth” ETFs that have minimal overlap with each other. None of the approximately 120 stocks found in the Rydex S&P 500 Pure Value ETF (RPV) are found in the S&P 500 Pure Growth ETF (RPG). Likewise, overlap between mid cap (RFG and RFV) and small cap (RZV and RZG) pure value and growth ETFs is minimal.

The correlations between these “pure style” ETFs is still strong – in excess of 0.75 in fact – but far weaker than the relationships between traditional value and growth indexes.

Disclosure: No positions at time of writing.