Every investor dreams of hitting a grand slam by investing in the next Apple or Netflix while the company is still small and its stock relatively undiscovered. The problem is that because many prospects fail to live up to their promise, investors who swing for the fences with small-capitalization stocks often end up striking out. This is where a well-diversified exchange-traded fund can come in handy.
Consider iShares Russell 2000 Growth ETF (IWO), which tracks an index comprising the faster-growing stocks in the small-cap Russell 2000 index. To determine which firms go into the ETF, Russell ranks the stocks in the 2000 index using three measures: share price to book value (assets minus liabilities); growth in sales per share over the previous five years; and forecasted two-year earnings growth. The most growth-oriented companies are put into Russell Growth and account for some 35% of the ETF’s assets, while the 35% that represent the cheapest stocks go into the Russell 2000 Value index and its corresponding ETF. Stocks that fall in the middle are assigned to both funds.
Although Growth holds nearly 1,200 stocks, it is heavily concentrated in two sectors: 48% of the ETF’s assets are in health care and technology stocks. That concentration helped the fund outpace the Russell 2000 by 6.9 percentage points and the Russell Value index by 13.6 points over the past year. The ETF charges 0.25% of assets annually.
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