IWF - IWF: Near The End Of Growth Rotation?

2023-08-01 08:29:42 ET

Summary

• 2023 has seen rate hikes and concerns of a recession, but a 'soft-landing' has been experienced instead.
• The iShares Russell 1000 Growth ETF has had a strong performance, outperforming the broad market and value stocks.
• IWF has high exposure to technology, consumer cyclical, and healthcare sectors, with large holdings dominating the portfolio.

2023 has been a well-anticipated year, with rate hikes and prospects for recession in an effort to combat inflation. With rates currently at the highest levels not seen in decades, a real economic recession was not really felt and many have called for a 'soft-landing' instead. Meanwhile, the equity market surprised many as growth stocks significantly outperformed value fueled by the AI/technology rally, which is unusual in a year with increasing rates. As AI stocks such as NVIDIA gained more than 200% year-to-date, it prompts us to compare and review growth ETFs such as IWF to understand its portfolio characteristics further.

The iShares Russell 1000 Growth ETF ( IWF ) "seeks to track the investment results of an index composed of large- and mid-capitalization U.S. equities that exhibit growth characteristics" - as constructed by the Russell 1000 Growth Index. As a result, the portfolio is highly exposed to technology, consumer cyclical, and healthcare sectors, where growth stocks mainly live.

Looking at its composition, IWF is quite dominated by large names, as both AAPL and MSFT represent nearly a quarter of the portfolio and the combined top 10 holdings represent half of the fund.

Performance and Competitor Review

As mentioned, IWF had a spectacular year-to-date performance with over 30% return, lagging only behind the pure technology sector with over 40% return, and significantly outperformed the broad market ( SPY ), small-cap growth stocks ( IWO ), and large-cap value stocks ( IWD ).

Since January 2021, however, the results look slightly different. Except for the technology sector ( XLK ) with strong outperformance and small-cap growth ( IWO ) with heavy underperformance, the rest share similar returns at around 15-20% over the 36-month period. This indicates that the strong performance in growth is mostly limited to large-cap, and the value-growth rotation which took place during this period has ended with pretty much a draw, with growth having a strong momentum for now.

Despite its strong performance, the fund actually suffered from net outflows of nearly $2bn, especially during early this year when investors broadly expected underperformance in growth stocks.

Comparing IWF with its peers, the fund is one of the biggest by AUM and has its expense ratio on the lower end. However, VONG which tracks the same index actually has a lower expense ratio at 0.08%, while VUG which tracks CRSP US Large Cap Growth Index has an even lower expense ratio at 0.04%. While there are some technical differences between IWF and VONG, a retail investor should definitely go for VONG with lower fees if available.

Risk Analytics

From the risk standpoint, IWF's risk level is quite well reflected by its strategy at ~22%, higher than the value stocks but lower than small-cap growth stocks.

Applying the Fama-French 3 Factor Model, 79% of IWF active risk relative to SPY can be attributed to value premium, where IWF favors equities with higher price-to-book ratios relative to SPY holdings. This indicates that the ETF is exactly doing what it should do.

Relative to the broad market (SPY), IWF has mostly outperformed as its rolling-Alpha remains elevated in the positive territory. Meanwhile, the rolling-Beta chart also demonstrates the sensitivity of IWF over SPY, which has been volatile but trading lower recently. As the rolling-Beta is now close to 1, this indicates that 1 point move in SPY will essentially lead to 1 point move in IWF as well. Overall, IWF now has a better risk-adjusted return compared to the broad market - as concluded from recent historical data.

Fundamental Deep Dives

The fund currently trades at a 34x P/E ratio, which is higher than SPY at roughly 23x and similar to the technology sector ( XLK ). This makes sense given the growth exposure. Looking across its top holdings, most of them actually have decent valuations with the exception of AMZN , NVDA , TSLA , and LLY - which all share very high earnings/revenue growth expectations.

Most of its holdings look decently profitable, but revenue growths are generally on the low or negative ends. This does not look great for the IWF given that growth stocks are indeed expecting to 'grow', especially on its topline.

Overall, Wall Street does have positive sentiments on these large growth names with median target price ranging from -0.5% for TSLA to 18.2% for MSFT despite poor revenue growth. These may be lifted following earning calls where large tech names mostly beating low expectations.

Conclusion

In short, IWF has demonstrated the expected growth characteristics in its portfolio while outperforming all other style-size combinations, including SPY since the start of 2023. While it demonstrates strong risk-adjusted returns, some large holdings in the fund still have questionable valuations and show low/ negative revenue growth. This may be concerning as to whether the growth rotation is coming to an end, hence my recommendation for hold until the growth expectations clear up further with short-term anticipation of valuation adjustments.

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