Market capitalization weighted index based ETFs are most common in the ETF world due to their simple methodology and low cost. Then there are some actively managed ETFs that promise to generate alpha by superior security selection. However active management usually comes with a much higher cost which is not always justified by the returns.
Thanks to continuous innovation in the ETF universe, now there are several strategies that lie in the spectrum between capitalization weighted strategies and active management. These strategies may try to outperform the market or provide more focused approach to a particular investing style.
Growth or Value—What’s Your Style?
Dividing the entire universe of stocks into ‘growth’ and ‘value’ buckets and then selecting stocks based on one’s investment objectives and risk tolerance remains the most popular approach to investing. (Read: 3 Unknown ETFs that continue to crush SPY)
Growth companies typically have above-average earnings growth potential and while these stocks exhibit higher volatility, they typically outperform the broader market during healthy economic environments.
On the other hand, value investors look for companies that they believe are trading below their intrinsic value. These stocks are usually less volatile and perform well during slower growth environments.
While many critics argue that such a distinction is flawed, the popularity of this simple approach is evident from the number of funds that adopt either growth or value style for selecting securities.
At the same time, distinction between these two styles is often vague and there is considerable overlap between the two styles.
‘Pure’ Approach to Growth and Value Style
S&P 500 pure style indexes divide one third of S&P 500 market capitalization as ‘Pure Growth and one third as ‘Pure Value’. These two buckets have no overlapping stocks. Index constituents are weighted by their style scores as opposed to market cap.
Thus ‘pure’ approaches eliminate any overlap between growth and value. Growth stocks are selected on the basis of three factors: sales growth, the ratio of earnings change to price and momentum. Value stocks are selected on the basis of three ratios: book value to price, earnings to price and sales to price.
How have they performed?
We looked at the 5-year performance (total returns) of S&P 500 Pure Growth and Pure Value indexes versus S&P 500 Growth and Value indexes as well as the broader S&P 500 index. (Read: 3 All-American ETFs to buy now)
S&P 500 Pure Growth index had an annualized return of 13.56% over the five-year period versus 9.20% for S&P 500 Growth index and 8.32% for S&P 500 index.
S&P 500 Pure Value index had an even more stellar performance with an annualized return of 15.62% over the five-year period, when the Value Index lagged behind the broader market with a 7.42% return versus 8.32% for S&P 500 index.
Guggenheim S&P 500 Pure Growth ETF (NYSEARCA:RPG)
Launched in March 2003, RPG tracks the S&P 500 Pure Growth Index, with a total of 110 stocks in its basket. The product is widely spread across individual securities, with the top security accounting for just 2.6% of the asset base. The top three sectors are Consumer Discretionary (30%), Healthcare (18%) and Information Technology (16%).
The product charges a reasonable expense ratio of 35 basis points. It has so far managed to attract assets of $545.1 million.
The P/E and P/B ratios are quite high for the fund at 43.6 and 5.0, respectively, suggesting a concentrated focus on growth.
Guggenheim S&P 500 Pure Value ETF (NYSEARCA:RPV)
RPV tracks the S&P 500 Pure Value Index holding 114 securities in its basket and charging investors 35 basis points a year in fees.
Top sectors currently are Financials (35%), Energy (12%) and Healthcare (11%). Like its growth counterpart, this fund is also well diversified among holdings with the top holding accounting for just 3.3% of total assets.
The fund has managed to attract about $273 million in assets so far only despite its outstanding performance. Deep focus on value stocks is evident from P/E and P/B ratios of 18.3 and 2.4 respectively.
The Bottom Line
Given their focused approach and solid performance, these pure style ETFs are definitely worth a look, even though they are slightly more expensive than their simpler cap weighted counterparts. They are excellent choices for investors seeking a play on strongest growth or value characteristics.
Another option could be holdings both these ETFs for a diversified play on the broader market and an outstanding potential to outperform. Holding both these ETFs in equal weights over the last five years would have rewarded investors with approximately 15.9% annualized return versus 8.8% for the S&P 500.
This article is brought to you courtesy of Neena Mishra From Zacks.