How to Beat the S&P 500 with Style ETFs

by on January 21, 2014 | ETFs Mentioned:

Diversity and innovation remain the driving forces behind the ETF industry’s impressive growth. With more than 1,500 ETFs available on the market today, investors have a plethora of strategies and asset classes to pick and choose from. Actively-managed and smart beta products have been shaking up the industry as more and more investors grow comfortable with utilizing these unique strategies, making it more difficult for some of the “plain vanilla” vehicles out there to get the attention they deserve. More specifically, we’re talking about investment style ETFs, which have allowed for easy and cost-efficient access to the age-old strategies of  “Value” and “Growth” investing [see 101 ETF Lessons Every Financial Advisor Should Learn].

What’s Your Style? Value vs. Growth

When it comes to tactical allocation, the debate between growth and value investing has always been a heated one among portfolio managers of all walks. Sticking exclusively to either growth or value stocks is appealing for the simple reason that it allows investors to define and focus on a strategy with specific principles. ETFs have made it easy and cheap for investors to hone in on both of these strategies; through the purchase of a single ticker, you can tap into a portfolio of securities that meet defined value or growth investment criteria [see Comparing Five Years of Alternative Weighting Methodologies].

Aside from the tremendous cost efficiencies that Growth and Value ETFs provide, these products also help to cut out the research (saving you time) that you would otherwise have to do yourself.

So which “style” works best? As you may have suspected, the answer isn’t straightforward; value-focused ETFs may be more appropriate for some investors in certain scenarios, while other may find growth-focused funds more appealing. To further assist with answering the age old question, below we compare the annual returns of the most prominent Growth and Value ETFs built around the coveted S&P 500 Index, as represented by State Street’s SPDR S&P 500 (SPY).

When all is said and done, it’s clear that both styles of ETFs boast a different set of pros and cons depending on your individual goals and risks preferences. Keep in mind also that the above comparison spans only the current bull market, and therefore it sheds no light on how these different ETFs might hold up during tough times on Wall Street. It’s important to take a look under the hood of each strategy to better understand why it might fare better or worse than other seemingly identical ETFs  [see Head-To-Head ETF Comparison Tool].

Value: iShares S&P 500 Value ETF (IVE) and Guggenheim S&P 500 Pure Value ETF (RPV)

The value investing approach revolves around identifying securities with low price-to-earnings ratios and above average dividend yields. More often than not, value stocks are associated with lackluster growth prospects coupled with stable dividends, because they tend to be more established companies that may be at or near maturity. The iShares Value ETF, IVE, is cheaper and more popular than its “Pure Value” counterpart, RPV, but its value-screening methodology isn’t nearly as strict; IVE holds approximately 340 securities from S&P’s starting lineup of 500, whereas RPV is comprised of roughly 120 stocks. While it may seem trivial, RPV’s stricter criteria for inclusion in its index has allowed it to outperform IVE as well as the broad market during four of the last five years [see also 101 High Yielding ETFs For Every Dividend Investor].

Growth: iShares S&P 500 Growth ETF (IVW) and Guggenheim S&P 500 Pure Growth ETF (RPG)

The growth investing approach revolves around identifying securities with rapidly growing earnings and higher revenue multiples. More often than not, growth stocks are in the early stages of their life cycle and therefore tend to exhibit much more volatility than their value counterparts, along with increased potential returns. The iShares Growth ETF, IVW, holds approximately 340 securities, whereas RPG’s stricter “pure” methodology results in a portfolio totaling just over 100 stocks. RPG’s stricter criteria for inclusion in its index has allowed it to outperform IVW as well as the broad market during three of the last five years. RPG is less popular and more expensive than IVW, but certainly warrants a closer look under the hood from anyone looking to embrace “growth-style” investing.

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Disclosure: No positions at time of writing.