PRFZ - PRFZ Outperforming More Popular IWM ETF

2023-07-28 09:00:00 ET

Summary

• The iShares Russell 2000 ETF tracks the performance of the Russell 2000 Index.
• Invesco FTSE RAFI US 1500 Small-Mid ETF tracks the FTSE RAFI™ US Mid Small 1500 Index.
• Here I compare both ETFs by holdings, risk factors, and most importantly, performance, with the results being I give PRFZ a Buy rating.
• I briefly address the question of why own Small-Cap stocks at all versus sticking with Large-Cap ones. Has the market changed too much to rely on the past repeating?

(This article was co-produced with Hoya Capital Real Estate )

Introduction

The first question Large-Cap investors might be asking is, "Why care about these stocks, I am doing fine?". Recent history supports that statement too.

But data back to 1972 reveals that both Mid-Cap and Small-Cap stocks outperformed Large-Cap stocks. Since those stocks are riskier, investment logic says they should then generate superior returns for investors. I will tackle that decision in the Portfolio strategy section later. For here, the decision is which of these ETFs has done better by investors since 2006, the period starting from when both existed.

• Invesco FTSE RAFI US 1500 Small-Mid ETF ( PRFZ )
• iShares Russell 2000 ETF ( IWM )

For investors looking for a Small-Cap index-based ETF, I rate the Invesco FTSE RAFI US 1500 Small-Mid ETF a Buy.

iShares Russell 2000 ETF review

I will start with the more popular ETF, which Seeking Alpha describes as:

The investment seeks to track the investment results of the Russell 2000® Index , which measures the performance of the small-capitalization sector of the U.S. equity market. The ETF started in 2000.

Index review

FTSE Russell describes the index as:

The Russell 2000® Index measures the performance of the small-cap segment of the US equity universe. The Russell 2000 Index is a subset of the Russell 3000® Index representing approximately 7% of the total market capitalization of that index, as of the most recent reconsitution. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership. The Russell 2000 is constructed to provide a comprehensive and unbiased small-cap barometer and is completely reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true small-cap opportunity set.

Source: research.ftserussell.com Index

A limited amount of data was provided.

IWM holdings

One benefit of adding these stocks to a portfolio is the sector weights differ greatly from what Large-Cap stock ETFs provide.

The top 20 holdings represent just 5.4% of the portfolio; the bottom half about 13%: not great but respectable percentage. As expected, there are 2000 stocks in this ETF.

IWM distributions

The pattern shows mid- and year-end payments many times are better than the other quarterly ones, something I only expect to see from International Equity funds.

With the CAGR for dividends improving, with the 3-year CAGR being almost 12%, up from both the five and ten year CAGRs, Seeking Alpha Quant ratings gives it an "A" grade.

Invesco FTSE RAFI US 1500 Small-Mid ETF review

Seeking Alpha describes this ETF as:

The investment seeks to track the investment results (before fees and expenses) of the FTSE RAFI™ US Mid Small 1500 Index . The ETF started in 2006.

Index review

FTSE Russell describes their index as:

FTSE partners with Research Affiliates on the FTSE RAFI Index Series. Index constituents are weighted using a composite of fundamental factors, including total cash dividends, free cash flow, total sales and book equity value. Prices and market values are not determinants of the index weights . Consequently the indices are less prone to excessive concentration arising from market fads, which can result in over-exposure to individual companies, sectors or countries. The FTSE RAFI® US Mid Small 1500 Index comprises the next 1500 US-listed companies with the largest RAFI fundamental values after the FTSE RAFI US 1000 Index.

Source: research.ftserussell.com Index

I italicized the key difference between the indices, thus the ETFs. Here, market-cap is not the weighting factor as it is for the R2000 Index; weighted factors are used instead. Other key index factors provided were:

PRFZ holdings

More on sectors when I compare the ETFs.

PRFZ holds just under 1500 stocks, with the Top 20 being 5.4% of the portfolio. Here, the lower half are 19% of the portfolio, giving them decent influence on the ETF's performance.

PRFZ distributions

Not quite as erratic, the payouts do vary quarterly here also. Growth shows the same pattern as those for IWM, earning this ETF an “A-" grade from Seeking Alpha Quant.

Comparing ETFs

I start the compare by looking at size and type allocations.

Despite PRFZ's name including Mid, clearly, they are a Small-Cap ETF, with a slightly larger tilt toward Value stocks than what IWM has. Next, I looked at how the sectors match up.

The ETFs have a large overlap in weight and stocks held compared to other ones I have reviewed. Only two sectors show a significant weight variation: Health Care favoring IWM; Consumer Discretionary by PRFZ. By individual positions, no stock has a weight difference greater than .3%.

I included the SPDR S&P 500 Trust ETF ( SPY ) in the next chart as it shows how SPY did versus the two ETFs reviewed here.

First, we see PRFZ has outperformed IWM since it started in 2006. It has also held its own against SPY CAGR-wise, though the risk ratios clearly favor the Large-Cap ETF.

Portfolio strategy

The question was partially answered above about why allocate any funds to stocks outside Large-Cap; summarized as diversification. As shown, Small-Cap stocks have outperformed for the last 50+ years. That pattern holds from 2000 onward but has not been the case recently. That said, investors who had funds that excluded big Tech companies lost a good part of their return versus owning an ETF like the SPY ETF.

A good question might be asking if the market has changed and thus history is not a good predictor of future performance. On that concept, here are points to ponder:

• ETFs did not exist in 1972 as the first one launched in 1993. This has changed how people invest.
• While IRAs started in 1974, the Roth IRAs did not appear until 1998. A majority of the contributions in these accounts flowed into funds, mostly based on an index. The ability to index invest has effects too.
• Active management of large AUM funds requires focusing on larger stocks or taking outsized positions in smaller stocks to affect the overall results.

Final thoughts

The PRFZ ETF has treated investors better than the larger, more well known IWM ETF based on the popular R2000 Index. By using factors other than market-cap, value stocks have more influence, which have outperformed Growth stock in the Small-Cap sector. For investors looking for a Small-Cap index-based ETF, I rate the Invesco FTSE RAFI US 1500 Small-Mid ETF a Buy.

There is another means of gaining Small-Cap, adding a total market-cap ETF, such as these two I compared: VTI Vs. SPTM For Total U.S. Equity Exposure .

For further details see: