The size factor may not command the attention of its momentum, quality and value counterparts, but that does not mean the size factor lacks for merit, particularly when applied as the backbone of an exchange traded fund.
The iShares MSCI USA Risk Weighted ETF (NYSEArca: SIZE), which turned two in April, is up 7.9% over the past year, topping the S&P 500 by nearly 120 basis points over that period. What makes SIZE interesting is how it negotiates the size factor in favor of investors. Most academics attribute the out-performance of the size factor to small-caps, but SIZE does things differently by focusing on smaller large-caps.
“It has almost no exposure to small-cap stocks. Instead, it tracks the MSCI USA Risk Weighted Index, which includes the same large- and mid-cap stocks as the broad MSCI USA Index. The risk-weighted benchmark reweights these stocks according to the inverse of their volatilities over the past three years, with a cap to improve diversification. This gives the least volatile stocks the largest weightings and skews the portfolio toward the smaller names in the MSCI USA Index,” notes Alex Bryan of Morningstar.
Part of a suite of factor-based ETFs developed at the request of the Arizona State Retirement System, SIZE consists of traditional U.S. large and mid-cap stocks, but it reweights the holdings based on a rules-based methodology that leans toward stocks with smaller average market-cap and lower-volatility. [iShares Launches Factor ETFs]
No stock accounts for more than 0.54% of SIZE’s weight, a trait that helps limit the ETF’s vulnerability to single-stock shocks. Additionally, the ETF does not lack for true large- and mega-caps among its top 10 holdings. That group includes PepsiCo (NYSE: PEP), Clorox (NYSE: CLX), Warren Buffett’s Berkshire Hathaway (NYSE: BRK-B) and Colgate-Palmolive (NYSE: CL).
Since one of SIZE’s primary objectives is to present investors with a low-risk alternative to traditional cap-weighted broad market funds, how the ETF mutes risk is an important factor. The MSCI USA Risk Weighted Index reweights each security in the parent index with the smaller market value, lower risk names taking on more prominent positions.
Risk weightings are calculated using the inverse of the historical variance of the stocks based on three years of weekly return data, according to iShares, allowing SIZE to emphasize the size and value factors. Those are oft-cited attributes of the out-performance offered by some smart beta ETFs.
SIZE “fund does not currently have a significant value tilt, which could reduce its potential long-term return advantage. At the end of June, it was trading at a similar multiple of forward earnings (19.0) to the MSCI USA Index (18.6), though it looked slightly cheaper on book value. At first glance, the portfolio does not appear to have a profitability tilt, either. On average, its holdings generated slightly lower returns on invested capital (ROIC) over the trailing 12 months through June 2015 than the constituents of the MSCI USA Index,” according to Morningstar.
SIZE has $233.2 million in assets under management and charges just 0.15% per year.
iShares MSCI USA Risk Weighted Index Fund