SPTM - ITOT: Why Market-Cap Weighting Isn't Optimal For Total Market ETFs

2024-07-09 12:04:03 ET

Summary

• ITOT is a low-cost total market fund representing approximately 4,000 U.S. securities. It's marketed to passive investors and has $58 billion in assets under management with a 0.03% expense ratio.
• ITOT's market-cap-weighting scheme is a weakness. While this works well for the large-cap segment, small and mid-cap investors are better served by factor funds that emphasize quality.
• The weakness appears when analyzing ITOT and SPY fundamentally. There is minimal or no improvement in growth and valuation, but quality takes a hit. This helps explain recent underperformance.
• I recommend separating your large, mid, and small-cap funds into three ETFs to replicate ITOT's composition. SPY is an excellent core holding, and this article provides suggestions for the remainder.

Investment Thesis

I last reviewed the iShares Core S&P Total U.S. Stock Market ETF ( ITOT ) on July 10, 2023, highlighting how its slightly better diversification compared to the SPDR® S&P 500® ETF Trust ( SPY ) came at the significant expense of quality. Based on this observation, I concluded readers should avoid ITOT. Since that article was published, it's lagged behind SPY by 1.78% on total returns....

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