Blog - Investing Notes

August 25, 2008 - Measuring the Value Premium with Style-based ETFs

Do popular style-based exchange-traded funds (ETF) confirm the existence of a 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 and quarterly adjusted closing prices (incorporating dividends) for these ETFs during October 2001 (the earliest quarter available for IWP-IWS) through June 2008, we find that:

The following table shows the average monthly value premium by capitalization category across the entire sample period (81 months). The average monthly value premium is small but positive for all three pairs. The monthly variabilities are fairly large compared to the average premiums, indicating that the sample is too small for firm conclusions. In fact, starting the analysis one month later (November 2001 rather than October 2001) more than doubles the average monthly value premiums for the Smallcap and Midcap categories.

For visualization, we switch to quarterly returns.

The next table shows the average quarterly value premium by capitalization category across the entire sample period (27 quarters). The average monthly value premium is positive for all three pairs and noticeably bigger for the largecap category. The quarterly variabilities are fairly large compared to the average premiums, again indicating that the sample is too small for firm conclusions. In fact, starting the analysis one quarter later (quarter ending March 2002 rather than quarter ending December 2001) more than triples the average monthly value premiums for the Smallcap and Midcap categories. Starting the analysis three quarters later (quarter ending September 2002) results in negative average value premiums for the Smallcap and Midcap categories.

The following chart plots the quarter-by-quarter value premiums for all three size categories over the entire sample period, offering a visual perspective on quarterly variabilities. A tendency for financial sector stocks to fall into the value category may explain some of the longer-term variability. The chart shows that, to the extent a value premium exists for these ETF pairs, it is unreliable on a quarterly or even annual basis.

In summary, a simple test with available data (about seven 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.