The growth of exchange-traded funds has created opportunities
for investors that weren't available in the past, and yet many
people aren't taking advantage of all the options now available to
them in terms of size and style in stock investing.
Indeed, the majority of investors continue to opt for a passive
approach to investing by simply buying into an ETF that tracks a
major index such as the S&P 500.
This strategy would have worked well if you were lucky enough to
buy into the SPDR S&P 500 ETF (NYSEArca:SPY) in March 2009. But
even though SPY has almost doubled since the market March 6 low
that year, it lags many of its closest competitors. A quick review
of size and style is in order.
The universe of stocks in the U.S. can be categorized in a
number of ways. One is by market capitalization-the market value of
the company based on multiplying share price by the number of
outstanding shares. The three categories are large-cap (over $10
billion), midcap ($1 billion to $10 billion) and small-cap ($100
million to $1 billion).
From there, size can be split into style categories that include
growth, value and core. Core is a mix of stocks that exhibit both
average growth and value characteristics. Stocks in the growth
class exhibit above-average growth as compared to their peers,
while value stocks are considered inexpensive relative to
To parse differences in returns, I looked at nine ETFs offered
by iShares that cover all the sizes and styles I mentioned above. I
compared the ETFs against each other during various time frames
dating back to the S&P 500's all-time high on Oct. 11,
I won't mention all of them by name here, but you can compare
all their returns on the table at the bottom of this story.
Smaller Is Better During A Bull Market
Stocks recently marked the two-year anniversary of a bull market
that began in March 2009. From the bottom through the end of
February of this year, the S&P 500 rose by an astounding 94
But of the nine ETFs I looked at, the best performer during that
period gained 174 percent, and the worst of the group returned 78
percent. All three of the large-cap ETFs separated by style-value,
core and growth-lagged the return of the S&P 500, while the
worst of the small- and midcap ETFs returned a minimum of 130
During bull markets, investors typically become less risk averse
and therefore are willing to take their chances on more aggressive
styles by choosing growth stocks over slower-moving large-cap value
options. Indeed, the iShares Morningstar Large-Cap Value ETF
(NYSEArca:JKF) was the laggard, with a gain of 77 percent, while
the iShares Morningstar Large-Cap Growth ETF (NYSEArca:JKE) gained
Just as investors often choose growth stocks in the large-cap
category during bull markets, some will take the next step to take
more risk on a small-cap ETF, versus a large-cap fund.
This tendency is clear in the returns I looked at, with the
iShares Morningstar Small-Cap Growth ETF (NYSEArca:JKK) gaining 140
Oddly enough, the best performer during the two-year bull market
has been the iShares Morningstar Small-Cap Value Index Fund
(NYSEArca:JKL), which gained 174 percent. An explanation for this
might be that a large number of once-high-growth stocks fell so
much during the market crash that they essentially became value
Go Big When The Bear Shows Up
During bear markets-in particular the one that began in October
2007 and ended on March 6, 2009-large-cap ETFs will outperform due
to risk aversion. The best-performing ETF during the bear market
was large-cap growth, JKE, which declined 51 percent-a bit less
than the S&P 500, which lost 56 percent.
The worst-performing ETFs were the small-cap value fund (NYSE
Arca:JKL), and the midcap value fund (NYSEArca:JKI), which is
somewhat surprising. I would have thought that the biggest losers
would have been growth stocks within the same asset classes, not
The Tale Of The Tape
When it comes down to investing for the long term, we must all
realize there will be both bull and bear markets. And, the
probability of success increases greatly by investing in ETFs that
can outperform through the peaks and troughs.
This leads to my final analysis of performance from the peak of
the S&P 500 in the fall of 2007 through the end of February
2011. This includes, as we all know too well, a nasty bear market
and, lest we forget, one of the most robust bull markets in the
history of stocks.
As a gauge, I'll use the S&P 500, which is around 15 percent
below the high it reached in mid-2007-not bad when considering what
has taken place over the last three years.
You could have done much worse-or better-depending on which of
the nine ETFs you selected to invest in. All three small-cap ETFs
generated positive returns of at least 5 percent, with the
small-cap value fund, JKL, leading the way with a 7 percent
The large-cap ETFs were the clear laggards, with the large-cap
value fund, JKF, down more than 28 percent. The performance gap of
35 percent between JKF and JKL over about 40 months is dramatic.
When annualized, that's a difference of about 11 percent per year.
To be clear, the 40 months I'm referring to span the time frame
from the market high in 2007 to the end of February.
2011 And Beyond
Now that I've shared all the past-performance numbers, I'll
leave you with a prediction for the future:I believe investors will
continue to lean toward the high-growth and small-cap ETFs as
overall tolerance for risk remains above normal.
That said, the moment the market begins to lose steam and
investors look to mitigate risk, the large-cap and value ETFs
should once again take over the leadership role.
|iShares Morningstar Large Core
|iShares Morningstar Large Value
|iShares Morningstar Large Growth
|iShares Morningstar Mid Core
|iShares Morningstar Mid Value
|iShares Morningstar Mid Growth
|iShares Morningstar Small Core
|iShares Morningstar Small Value
|iShares Morningstar Small Growth
|S&P 500 Index
Matthew D. McCall is editor of The ETF Bulletin and
president of Penn Financial Group LLC, a New York-based
wealth management firm specializing in investment strategies
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