From David Fabian: One of the tremendous benefits of using exchange-traded funds (ETFs) is the ability to customize your exposure to target a specific theme. This flexibility allows for greater control of your sector and position sizing relative to a broad-market benchmark such as the S&P 500 Index.
Investors who are looking to build a solid foundation should start out with a traditional core holding such as the iShares S&P 500 ETF (NYSE:IVV) or the Vanguard Total Stock Market ETF (NYSE:VTI). Both of these funds provide market-cap weighted exposure to every sector of the economy. Ultimately, that means transparent correlation to the U.S. stock market at an extremely low cost. You own the whole shebang.
For those that want to get a little more sophisticated, there can be significant opportunities to overweight your holdings towards a specific subset of stocks using a growth or value-focused index. This may be appropriate for a portion of your stock allocation as a tactical addition or a fundamental enhancement.
Below is a list of reasons why this may make sense:
Whatever the case may be, there are a number of tools and indexes to achieve your goals. For example, the iShares S&P 500 Growth ETF (NYSE:IVW) and iShares S&P 500 Value ETF (NYSE:IVE) are two ways of splitting this large-cap index apart. The interesting thing about IVW and IVE is that they aren’t pure growth or value. They also hold stocks with a blended or undefined classification as well.
IVE holds 360 stocks from the S&P 500 with a focus on value characteristics. The top sectors in this ETF include: financials (22%), energy (13%), and health care (12%). By contrast, IVW focuses on growth companies with 318 holdings that overweight technology (34%), consumer discretionary (18%), and health care (17%).
A look at a 3-year chart shows that IVW (growth) has added meaningful alpha above the traditional benchmark and IVE (value) has lagged.
The results may speak for themselves in terms of the dominant sector positioning. Technology and consumer discretionary has been near the top of the pack, while financial and energy stocks have lagged during this time span.
There are many ways that investors can interpret this data. Some may feel inclined to capitalize on the relative strength in growth, while others may feel that value indexes are due to play catch up. There are also other considerations such as dividend yield, valuation ratios, and index construction criteria that may play a role in this decision as well.
In a real world example, we implemented a change to our client portfolios this year to move away from a smart beta low-volatility index to IVE. This allowed us to shift our exposure away from stocks that we believed to be fundamentally overvalued to areas with greater potential for sustainable returns. This also coincided with our firm views on the top sector positions within this ETF and our market outlook moving forward. When paired with other diversified equity positions, it creates a reasonable tilt towards the value side of the ledger.
One important thing to note when selecting growth our value ETFs is how they complement existing holdings. It doesn’t make sense to own the exact same share amounts of each because you are essentially reverting back to the original index and over-complicating your portfolio. This is a common misuse of the growth or value theme rather than to give the portfolio a meaningful bias.
It’s also worth noting that there is a large menu of available options in both passive and actively managed ETFs. Investors can choose between varying index providers or portfolio construction techniques that make the most sense for their risk tolerance and long-term goals. The ability to fine-tune your asset allocation and exposure with complete transparency is just one more reason why I love these tools.
This article is brought to you courtesy of FMD Capital.