IWF - IWF: Price Isn't Everything; Favor Growth Over Value

2023-12-22 23:34:34 ET

Summary

• Russell 1000 Growth has recovered most of last year’s underperformance.
• While growth stocks now screen richly on an absolute basis, they remain very investable relative to their attractive fundamentals.
• The low-cost, highly liquid IWF is a great way to gain exposure to an index of the highest-quality growth names on the market.

The divergence between the return profiles of iShares’ Russell 1000 Growth ( IWF ) and Russell 1000 Value ETFs ( IWD ) has been striking this year. For the most part, IWF’s outperformance has been boosted by its significant overweight to tech (44% of Russell 1000 Growth), as well as the ‘Magnificent 7’ comprising Apple (AAPL), Microsoft (MSFT), Alphabet (GOOGL), Amazon (AMZN), Nvidia (NVDA), Meta Platforms ( META ) and Tesla (TSLA). In contrast, value-oriented funds like IWD skew toward banks, a relative sector underperformer this year amid a combination of cyclical and structural headwinds. Further exacerbating the growth-value gap was the Fed’s dovish turn this month, driving yields lower (and valuations higher) across the board. In the likely event we see a ‘soft landing’ economic outcome as well, the setup is clear for further growth outperformance next year.

The catch, as always with growth, is the premium investors have to pay for these names. To some extent, these concerns are valid – not all of the widening valuation gap between growth and value can be explained by earnings growth. Plus, the chances we see another year of market cap expansion from the ‘Magnificent 7’ seems low, given the re-rating the group has already seen. On the whole, though, the growth-oriented IWF is benefiting from some impressive underlying earnings momentum across a broader spectrum of stocks heading into 2024. So even if multiples flatline, growth stocks should quite easily grow into their valuations over time. Relative to the steep decline in the risk-free rate (i.e., the ten-year Treasury bond) as well, stocks don’t screen all that richly relative to a lower cost of equity. On balance, the current micro/macro setup strongly favors growth over value; low-cost Russell 1000 Growth funds like IWF should benefit.

iShares Russell 1000 Growth ETF Overview – A Tech-Heavy Vehicle to Ride US Growth

The iShares Russell 1000 Growth ETF tracks (pre-expenses) the total return performance of US-listed large-cap growth stocks via the Russell 1000 Growth Index. Unlike more straightforward Russell 1000 trackers like the iShares Russell 1000 ETF (IWB), IWF applies a multivariable filter comprising forward (per I/B/E/S forecasts) and historical growth numbers, as well as price-to-book ratios. The result is a smaller subset of the 1000-stock Russell portfolio, allowing investors to express a specific style view – in this case, growth.

IWF held ~$81.7bn of assets at the time of writing, making it the largest and most liquid Russell 1000 Growth tracker available. That said, the fund maintains a relatively higher expense ratio at 0.2% - by comparison, IWF’s smaller ETF comparable, Vanguard's Russell 1000 Growth ETF (VONG), charges a lower 0.08%.

The fund is spread across 443 holdings (including cash), with its growth filter underpinning an outsized sector allocation to Information Technology (43.6%). Consumer Discretionary and Communication are listed as the second and third-largest exposures at 11.4% and 10.5%, though many holdings classified here (e.g., AMZN in ‘Consumer Discretionary’ and GOOGLE in ‘Communication’) are tech or tech-enabled as well.

VONG, on the other hand, lists its Information Technology allocation at a higher 52.2%, though the delta to IWF is largely down to classification differences. Most notably, the Vanguard tracker doesn’t break out certain tech stocks into ‘Communication’; instead, it lists a separate ‘Telecommunications’ sector with no tech overlap. Either way, both funds have their fortunes very closely tied to their main sector exposures, so investors should be mindful of the concentration risks and heightened volatility relative to broader equity indices.

In line with the outsized sector exposure, IWF’s 443-stock portfolio features a much heavier emphasis on major tech franchises than broader equity benchmarks. All of the ‘Magnificent 7’ are particularly prominent here, with the likes of AAPL, MSFT, AMZN, NVDA, and GOOGL getting nearly double the % allocation of a comparable Russell 1000 tracker like IWB. The trade-off is that slower growth, cash-generative ‘value’ names like Berkshire Hathaway (BRK.A) and JPMorgan ( JPM ) are omitted from IWF. Key comparable VONG has an identical single-stock composition, albeit with some minor weightage differences and two additional money market fund holdings.

iShares Russell 1000 Growth ETF Performance – A Golden Age for Growth

Following a challenging 2022, growth stocks have rebounded strongly this year and IWF has risen on the uptrend. The YTD total return, currently at +40.8%, has far outpaced both the Russell 1000 Value (+9.1%) and the unfiltered Russell 1000 ETFs (+24.4%), more than making up for last year’s drawdown. Over longer five and ten-year timelines, IWF has also outperformed iShares’ other Russell 1000 offerings, delivering +16.2% and +14.5%, respectively.

That said, Vanguard’s offering, VONG, has slightly outperformed IWF, mainly due to its lower fees. To both managers’ credit, IWF and VONG also maintain very narrow fee-adjusted tracking errors relative to their benchmark Russell 1000 Growth Index. Given the low performance delta between the funds, liquidity is the key differentiator. Here, IWF maintains a far tighter bid/ask spread (0.01% 30-day median) and trades a lot more volume than VONG (>1m daily; ~1.5m 30-day average), so investors trading in size would still be better off with IWF.

Income-wise, at ~0.7% on a trailing twelve-month basis, the IWF yield isn’t bad by growth fund standards. Don't expect much more on this front, though, as the fund's higher concentration in growthy tech names should continue to keep distributions structurally low. Yet, the fund more than makes up for any distribution shortfalls with superior capital growth. With new tech themes like AI and robotics further extending reinvestment runways for IWF’s group of market leaders, deploying excess cash should continue to generate some very attractive growth rates going forward.

The catch is the price – Russell 1000 growth trades over ten turns higher than the pure-play Russell 1000 at ~33x trailing earnings (~36x ex-negative earnings). This needs to be balanced, however, against the significantly higher earnings growth potential (~21.5% average annual rate over the last five years) offered by Russell 1000 growth stocks, as well as their best-in-class return on equity profile (~34%). And on the technical side, an environment of declining real rates typically rewards growth valuations. So while the IWF portfolio might seem pricey at first glance, its underlying fundamentals more than justify the price, in my view.

Price Isn’t Everything; Favor Growth Over Value

Growth is now back in vogue and IWF’s outperformance relative to its value-focused ETF counterpart, IWD, reflects this. The catch is that valuations, at least in absolute terms, are also higher, as investors reposition according to a much-improved macro/micro setup. On a relative basis, though, the current growth premium vs. value is well-supported by tailwinds from earnings and a much lower cost of equity following the recent decline in risk-free rates. So barring any tail risks or a ‘’hard landing’ outcome (unlikely given the Q4 GDP nowcast is tracking at a very solid +2.7%), I think IWF investors should still come out ahead here. On balance, IWF’s low-cost/high-quality portfolio remains a great pick for investors looking to compound capital at above-market rates over long time horizons.

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