WisdomTree Goes For Growth with ROI

Includes: IVW, IWF, PRF, ROI, RWL, VUG
by: IndexUniverse

Since first jumping into the exchange-traded funds market two-plus years ago with 20 dividend-weighted portfolios, WisdomTree Investments has firmly been cast as a value-styled management shop.

That focus on weighting index-based ETF portfolios on business fundamentals—rather than traditional market-cap size figures—hasn't changed. But the New York-based firm launched Thursday an ETF focused squarely on large-cap growth stocks.

By itself, that wouldn't seem to be a major introduction. Diversified large-cap growth funds, after all, aren't exactly out of the ordinary. But two items stand to separate the WisdomTree LargeCap Growth ETF (NYSEArca: ROI) from the pack.

For one, the new fund focuses on corporate earnings, otherwise known as net income or profit, to weight stocks in its portfolio. That's different from rivals such as the $9.2 billion iShares Russell 1000 Growth Index (NYSEArca: IWF) and the $4.6 billion iShares S&P 500 Growth Index (NYSEArca: IVW). Both use straight market capitalization sizes to determine portfolio weights.

"The only pure competitors for ROI on the large growth side are traditional market-cap-sized indexes," said Luciano Siracusano, WisdomTree's chief investment strategist.

The lowest-priced large-cap growth ETF on the market is the Vanguard Growth ETF (NYSEArca: VUG). It has an expense ratio of 0.10% and tracks the MSCI U.S. Prime Market Growth Index. WisdomTree's ROI is expected to be 0.38% per year.

That leads to the second big point of departure for the new ETF. As an early advocate of using fundamental data rather than market-cap size metrics to weight portfolios, WisdomTree is a pioneering nontraditional ETF provider. Besides dividend streams, its portfolios are branching into another key measure to value businesses -- net earnings.

Assessing The Field

WisdomTree isn't alone in offering nontraditional index-based ETFs. PowerShares has a series of funds based on the FTSE RAFI indexes created by Research Affiliates and FTSE. Those use a broad set of fundamental valuations to design portfolios. The closest in terms of style to ROI is probably the PowerShares FTSE RAFI US 1000 Portfolio (NYSEArca: PRF). But that's categorized as a large-cap value fund by Morningstar.

Another nontraditional ETF provider using different fundamental valuations is RevenueShares. Its closest rival to ROI would be the RevenueShares Large Cap ETF (NYSE: RWL). It takes the blue-chip universe and weights those names by annual sales. And again, Morningstar categorizes RWL as a large value fund.

The closest competitor is probably SPA ETF's MarketGrader Large Cap ETF (NYSEArca: SZG), which uses a quantitative strategy to select 100 large-cap stocks. It is classified as a large-cap growth fund by Morningstar, although it is not explicitly screened to capture growth stocks alone.

ROI is the only non-traditional ETF with an explicit growth focus.

ROI's index starts with around 300 stocks based on four growth factors: earnings-per-share growth; sales-per-share growth; book-value-per-share growth and stock-price-per-share growth.

By contrast, the Russell 1000 Growth Index uses a combination of price-to-book values and projected earnings estimates. Other benchmarks throw in a few other factors to create a different valuation mix.

"All of the pure growth indexes use multiple factors to select components," said Siracusano. "But they determine weightings in the same way -- by market capitalization sizes."

Even though the benchmark underlying WisdomTree's new fund uses a different methodology to rank stocks, ROI's list of constituents looks much the same as its market cap weighted rivals. For example, some 17 of the top 20 companies listed in the WisdomTree LargeCap Growth Index at the time of its last rebalancing were also in the Russell 1000 Growth Index as well as the S&P 500 Growth Index.

"But since we weight our index by [net] earnings, the characteristics are different from the other growth indexes," said Siracusano.

Backtested data from WisdomTree shows its index has a lower price-earnings ratio. Here's how it shaped up heading into November:


P/E Ratio









In the past 10 years through Sept. 30, WisdomTree says its large growth index outperformed the Russell 1000 Growth index by an average of about four percentage points per year. It lists the following average annualized returns for that period:

  • 4.76% for the WisdomTree LargeCap Growth Index
  • 3.06% for the S&P 500 Index
  • 0.59% for the Russell 1000 Growth Index

"We created it to provide investors with an ability to own growth companies, but in a portfolio that has a lower PE ratio than other cap-weighted growth funds," said Jeremy Schwartz, WisdomTree's research director.

Looking Underneath The Hood

The WisdomTree LargeCap Growth benchmark is rebalanced once a year. After its last reconstitution, on March 31, several significant differences showed up compared with growth indexes that stuck to market-cap weighting methodologies.

One was that Apple (Nasdaq: AAPL) was given a larger weighting than Occidental Petroleum (NYSE: OXY). In a traditionally weighted index, the computer maker could expect to receive more than twice the weighting than the oil producer since its market cap was about $127 billion and Occidental's was around $60 billion at the time.

But in the WisdomTree index, more weight was actually given to Occidental since it had greater net profits -- $5 billion compared to Apple's $4 billion.

Another example is Google (Nasdaq: GOOG). It wasn't as high in the WisdomTree index as in the other major growth indexes. Perhaps most notably, ROI had Berkshire Hathaway among its Top 10, whereas none of the other indexes did.

In terms of sectors, Schwartz says that the WisdomTree index has the highest weighting in Technology, just like the S&P and the Russell index. The Vanguard benchmark, the MSCI US Prime Market Growth Index, has 394 holdings and a similar sector breakdown as the Russell 1000 Growth Index and S&P 500 Growth Index.

"We're cutting out the PE multiples from our weightings system," said Schwartz. "We're looking at the bottom line for corporate profits to weight our index."

In other ways, the indexes are similar, even given their distinct methodologies. In terms of holdings, the WisdomTree index has 300 growth stocks, similar to the S&P 500 Growth, which has 315 holdings. The Russell 1000 Growth stands apart in terms of holdings, with 600 stocks. With the lowest number of holdings among the three, the WisdomTree index is the most large-cap-oriented.

ROI's expense ratio is expected to wind up slightly less than PowerShares' lineup of RAFI-based index funds. It recently lowered costs on the domestic fundamentally weighted ETFs to 0.39%. (See story here)