VBR - VTWV: An ETF To Bet On Value And Size

2023-03-06 16:05:17 ET

Summary

• Vanguard Russell 2000 Value ETF tracks a small cap value index.
• The strategy is backed by the Fama and French three factor model.
• However, the fund has been lagging other small-cap value funds.
• It may be partly explained by two shortcomings in the underlying index.

This ETF article series aims at evaluating products regarding the relative past performance of their strategies and quality metrics of their current portfolios. As holdings and weights change over time, updated reviews are posted when necessary.

VTWV strategy and portfolio

The Vanguard Russell 2000 Value ETF ( VTWV ) has been tracking the Russell 2000 Value Index since September 2010. It has 1381 holdings, a 12-month distribution yield of 1.91% and a total expense ratio of 0.15%. It is a direct competitor of the iShares Russell 2000 Value ETF ( IWN ), which tracks the same underlying index and whose total expense ratio is 0.23%. IWN is an older fund (launched in July 2000), much more liquid and much larger (about $12.4B in assets vs $877M for VTWV).

The fund’s strategy combines two of the three factors of the original Fama-French model : size (“smaller is better”) and value. The underlying index measures the performance of a small cap segment of the US stock market. It includes companies with lower price-to-book ratios and lower expected growth values in the parent index Russell 2000. As expected, aggregate valuation ratios of VTWV are lower than for the iShares Russell 2000 ETF ( IWM ), as reported in the next table.

Source: Fidelity

The heaviest sector in the portfolio is financials, with 27.2% of asset value. Compared to the parent index, the fund massively overweight this sector, along with real estate, utilities, and consumer discretionary to a lesser extent. It underweights mostly information technology, healthcare and communication services.

The top 10 holdings represent 4.5% of the portfolio value and the heaviest names weight 0.5%, so risks related to individual companies are very low. The next table lists their weights and valuation ratios.

Ratios: Portfolio123

Historical performance

Since inception (09/20/2010) the annualized return is 9.64% vs. 9.55% for IWN, its competitor with the same index. The difference is immaterial, so I will use IWN to assess the underlying index on a longer period.

Since 8/1/2000, the Russell 2000 Value Index has returned 562.6% vs. 413.8% for the Russell 2000. The difference in annualized return is 1.2 percentage point. The risk measured in drawdown and standard deviation of monthly returns (volatility) is similar.

Data calculated with Portfolio123

In the last 3 years, VTWV also beats the Russell 2000. However, it lags its main competitors: the iShares S&P Small-Cap 600 Value ETF ( IJS ), the Vanguard Small Cap Value Index Fund ( VBR ) and the Avantis U.S. Small Cap Value ETF ( AVUV ). The actively managed fund AVUV is the best performer by far.

Comparing VTWV with my Dashboard List model

The Dashboard List is a list of 80 stocks in the S&P 1500 index, updated every month based on a simple quantitative methodology. All stocks in the Dashboard List are cheaper than their respective industry median in Price/Earnings, Price/Sales and Price/Free Cash Flow. After this filter, the 10 companies with the highest Return on Equity in every sector are kept in the list. Some sectors are grouped together: energy with materials, communication with technology. Real estate is excluded because these valuation metrics don't work well in this sector. I have been updating the Dashboard List every month on Seeking Alpha since December 2015, first in free-access articles, then in Quantitative Risk & Value.

The next table compares the Russell 2000 Value Index (represented by IWN) with the Dashboard List model, with a tweak: here the list is reconstituted annually instead of once a month to make it comparable to a passive index.

Past performance is not a guarantee of future returns. Data Source: Portfolio123

The Dashboard List beats VTWV index by 3.3 percentage points in annualized return, and also shows a lower volatility. However, the ETF performance is real, whereas the model performance is hypothetical.

A risky concept of value

Using the price/book ratio (P/B) as main value factor adds some risk in the strategy. Historical data show that a large group of companies with low P/B has a higher probability to hold value traps than a same-size group with low price/earnings, price/sales or price/free cash flow. Statistically, such a group will also have a higher volatility and deeper drawdowns in price. The next table shows the return and risk metrics of the cheapest quarter of the S&P 500 (i.e. 125 stocks) measured in price/book, price/earnings, price/sales and price/free cash flow. The sets are reconstituted annually between 1/1/2000 and 1/1/2023 with elements in equal weight.

Data calculated with Portfolio123

This explains my choice of not using P/B in the Dashboard List model.

Takeaway

Vanguard Russell 2000 Value ETF holds over 1300 small caps with value characteristics in the parent index Russell 2000. The idea of mixing the value and size factors makes a lot of sense. The strategy is closely related to the Fama-French model. The choice between VTWV and its same index competitor IWN should be driven by use cases. Buy-and-hold investors should prefer VTWV for its lower expense ratio. A higher liquidity makes IWN a better instrument for tactical asset allocation and swing trading. The underlying index has slightly outperformed the Russell 2000 in 23 years. However, it has underperformed several small-cap value funds in the last 3 years. In this time interval, Avantis U.S. Small Cap Value ETF has been the best performer by a wide margin. There are two points I don’t like in the Russell 2000 Value Index. First, ranking stocks regardless of industries results in overweighting financials. Value metrics work better to rank stocks in homogeneous sets (sector, industry). The second shortcoming is using price/book as the main valuation ratio. Although it is the historical value factor from the Fama-French model, statistics show it adds some risk in the strategy. My Dashboard List model uses three valuation metrics, but not this one.

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