In the 2000-2002 bear, one’s portfolio risk was directly related to the amount of tech exposure he/she carried. The more tech, the bigger the downside slide.
Similarly, in the 2007-2009 collapse, the extent of financial stock exposure exacerbated one’s possibility of loss. Insurance, real estate, financial services, banks — the more you held, the more you suffered.
With the Congressional Oversight Panel warning on Tuesday (8/11/09) that financial institutions still had plenty of “toxic assets” on their books, it’s possible that some folks may wish to limit their allocation to less than 10% for the questionable sector. To further control risk, one may also want to make sure that an exchange-traded fund isn’t concentrated in a handful of stocks.
For instance, the iShares MSCI Mexico Fund (NYSEARCA:EWW) has 24% in a single company, American Movil (NASDAQ:AMOV), one of the leading Latin American mobile phone service providers. In fact, EWW has 66% committed to its top 10 holdings. Granted, EWW may be a terrific way to get Latin American flavor, but it is far riskier than the regional iShares Latin America (NYSEARCA:ILF) or the pan-emerging nation fund, iShares MSCI Emerging Markets (NYSEARCA:EEM).
It follows that another risk reduction measure is to make sure that no single stock accounts for too much of a fund’s direction. By limiting the top 10 holdings to 10%, one is ensuring a very significant number of stocks in the ETF… perhaps 100 or more companies.
Screening for a low percentage of financials as well as a low percentage assigned to a fund’s top 10 holdings… you might think it would be difficult to achieve market-beating performance. But in fact, there are a variety of funds that outperformed the S&P 500 SPDR Trust’s (NYSEARCA:SPY) amazing 50% run-up off of the March lows.
|Small Caps: Redefining Risk?|
|% in Top 10||% Above||% Exposure|
|SPDR Dow Jones Small Cap Growth||(Pending:DSG)||4.7||72.9||7.2|
|iShares Russell 2000 Growth Index||(NYSEARCA:IWO)||4.8||61.7||5.9|
|Vanguard Small Cap Growth ETF||(NYSEARCA:VBK)||5.1||68.5||7.6|
|First Trust Small Cap Core AlphaDEX||(NASDAQ:FYX)||7.8||81.9||9.9|
|SPDR Dow Jones Mid Cap Growth||(NYSE:EMG)||8.1||73.9||5.7|
|iShares Morningstar Small Growth Index||(NYSEARCA:JKK)||8.6||60.0||7.0|
|iShares Russell Midcap Growth Index||(NYSEARCA:IWP)||8.7||56.4||9.1|
|First Trust Mid Cap Core AlphaDEX||(NASDAQ:FNX)||8.8||74.6||8.7|
A robust number of small and mid cap funds showed up in this screen. In fact, small cap funds stole the show, with gains off the bear bottom ranging from 60%-82%!
Investors are often told that small company stocks are riskier than large company stock… that growth investing is riskier than value investing. Yet in the last few years, it seems that large cap value has been a tougher ride than small-cap growth. Here’s a bear-market-inception chart of the iShares Russell 1000 Large Value (NYSEARCA:IWD) compared against a younger sibling, iShares Russell 2000 Growth (IWO). It seems to me that the downside risks are pretty similar, while upside potential favors the small growers.