Defensive stocks are those that pay steady dividends and whose returns are generally less sensitive to the business cycle. They include consumer staples, health care and utility sectors. A recent Bloomberg article suggests that investors crowding into defensive stocks have made their prices too steep.
If so, growth stocks may be cheap by comparison. A quick look at growth ETFs might help those who follow this line of thought and tend to agree with it.
The Big Dogs
With 50 ETFs tracking U.S. growth stocks, the task seems overwhelming. Let's use a "follow-the-money" approach, looking both at assets under management and new investment flows.
The three largest growth funds by assets are the iShares Russell 1000 Growth Index Fund (NYSEArca:IWF), the iShares S'P 500 Growth Index Fund (NYSEArca:IVW) and the Vanguard Growth ETF (NYSEArca:VUG). These three funds are huge, with billions in assets.
I find it interesting that the most popular growth funds are large-cap, not total market. These funds de-select what would presumably be the "growthiest" part of the market-cap spectrum:small-caps. I can guess why:With record volatility, investors want growth without exposure to the frothiest part of the market.
The net fund flows for these three ETFs looks interesting too. Despite all the talk about the popularity of defensive stocks, each of these three growth ETFs attracted serious new money in 2011. Through Dec. 23, IWF gathered $1.35 billion; VUG $921 million; and IVW $452 million.
So, what are the differences between the three funds that will drive performance for 2012?
A peek at sector exposure reveals some surprises. The two iShares funds, IWF and IVW, show an unexpected top sector:consumer noncyclicals. For VUG, consumer noncyclicals is a close second.
IVW stands out most in this respect, with over 30 percent in consumer noncyclicals, led by consumer staples giants Johnson ' Johnson and Procter ' Gamble in its list of top 10 stocks. From a sector point of view, these growths stocks aren't radically "growthy." Maybe a contrarian growth play isn't so daring after all.
Why do these funds have so much consumer noncyclical exposure, a sector commonly associated with defensive stocks? Simply put, none of the three funds uses a "style-pure" selection method.
This means some stocksâespecially huge firms that have migrated from either end of the style spectrum toward the centerâhave parts of their market cap assigned to both growth and value. Bottom line:The funds' portfolios will show significant tilts from a large-cap portfolio, but not radical differences.
Size And Style
Sectors aside, we can look at these funds by market cap and by style.
IVW leans toward mega cap, with the highest average market cap of its constituents at over $100 billion. This makes sense, as it pulls from the uppermost part of the marketâthe S'P 500âcompared with the other two.
VUG leans away from mega cap, with an average market cap of $74.2 billion. Based on these figures, I'd expect VUG to have higher beta to the broad market than IVW. VUG should lead IVW when the broad market is up, but lag when it's down.
Looking at style, IWF seems "growthiest" based on price-to-earnings and price-to-book data, while VUG leans more toward value.
IVW shows the highest dividend ratio, consistent with its mega-cap leaning and its big helping of consumer noncyclical stocks. IVW's higher dividend supports my lower-beta thesis, at least on the down side. IVW has an edge on VUG and IWF in a down market thanks to its dividend ratio.
IVW also looks slightly less risky from another point of view. IVW has the lowest volatility of the three funds as measured by one-year standard deviation of weekly returns at 21.6 vs. 22.6 for IWF and 22.7 for VUG, based on Bloomberg data.
Costs And Benefits
All three funds are relatively cheap to own. Direct costs are low:IWF charges 0.20 percent, IVW charges 0.18 percent and VUG leads the pack at 0.12 percent. Indirect costsâtransactional costs from tradingâalso look low for all three funds, based on average daily share volume and other liquidity measures.
In my view, the costs of the three are close enough not to matter. The differences in the funds' respective exposures matter more.
With its heavy dose of consumer noncyclicals and mega-cap tilt, IVW feels a bit too stodgy for a growth fund to me. Of the remaining two, I like IWF over VUG based on its higher allocation to the energy sector.
I've only touched on a handful of growth funds by assets. There are dozens more. Our ECS fund sorter can help you winnow down the choices.
Who knows what macro forces will buffet U.S. equity performance in 2012?
But compared with Europe and emerging markets, U.S. stocks might win the ugly-dog contest. And if defensive stocks are overpriced, the growth half of the U.S. market just might emerge as top dog.
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