Blog - Investing Notes

June 29, 2008 - Update: Measuring the Value Premium with Style-based ETFs

Do popular style-based exchange-traded funds (ETF) confirm the existence of an exploitable value premium? To investigate, we compare the difference in returns (value minus growth) for each of the following three matched pairs of value-growth ETFs:

iShares Russell 2000 (Smallcap) Growth Index (IWO)
iShares Russell 2000 (Smallcap) Value Index (IWN)
iShares Russell Midcap Growth Index (IWP)
iShares Russell Midcap Value Index (IWS)
iShares Russell 1000 (Largecap) Growth Index (IWF)
iShares Russell 1000 (Largecap) Value Index (IWD)

Using monthly adjusted closing prices (incorporating dividends) for these ETFs during September 2001 (the earliest quarter available for IWP-IWS) through June 2009 (94 months), we find that:

The following table summarizes the average monthly value-minus-growth returns and standard deviations of monthly returns by capitalization category across the entire sample period. The average returns are small but positive for all three pairs. The monthly variabilities are very large compared to the averages, making conclusions elusive. In fact, excluding the two best months for value (February 2002 and September 2008) flips all three monthly averages negative. Excluding the two worst months for value (October 2001 and January 2009) roughly triples the monthly averages.

Is there a trend in the value premium over the sample period?

The following chart plots monthly value-minus-growth returns by capitalization category across the entire sample period, along with associated linear best-fit trend lines. All three trend lines have negative slopes, suggesting that the value premium has declined over the sample period (to negative). Volatilities of value-minus-growth returns appear to rise during bear markets.

For a different perspective, we look at annual returns.

The final chart shows the value-minus-growth returns by capitalization category by year across the entire sample period. Results for 2009 are partial through most of June. Through (since) 2006, value-minus-growth has three good years, three neutral years and two bad years. The wide swings in value-minus-growth returns makes forming any beliefs about the long-term averages difficult.

In summary, a simple test with available data (about eight years) does not support a belief that investors can reliably capture a substantial value premium via style-based ETFs.

For related research, see Blog Synthesis: The Value Premium.