As the name implies, the iShares Russell 2000 ETF (NYSEARCA:IWM) is a passively managed vehicle that tracks the Russell 2000 Index. Since the ETF's inception over 22 years back, it has managed to amass a whopping $55bn in AUM and is currently one of the most popular ETF products around.
What Type of Companies Are In IWM?
IWM's tracking index- The Russell 2000, is a subset of the broader Russell 3000 index, which in turn, is designed to capture the top 3000 US public stocks (ranked on the basis of market-cap), which also represents 98% of all publicly traded US stocks; the Russell 2000 represents the bottom 2000 stocks of this broad subset and is generally used as a benchmark when gauging the performance of small-cap oriented products. I'm not entirely convinced this should be the case, as IWM's own current weighted average market-cap works out to $3.39bn, which should make it more suited for the mid-cap universe.
Regardless, also note that currently, mid-cap stocks dominate IWM's portfolio, with a 53% weight, whilst small-caps and micro-caps account for 40% and 6%, respectively; a minute component of this portfolio consists of large-cap stocks.
I think it's also fair to say that IWM comes across as a well-spread-out ETF with the top 10 stocks only accounting for less than 4% of the total portfolio. Besides, no single sector accounts for more than 16.5% of the total holdings. This lack of concentration is a welcome feature when you're dabbling with the small-cap universe as returns can be quite volatile and streaky, and it pays to hedge your bets across multiple avenues. Having said that, you could also make a case for IWM as something of a cyclical play, as both the financials sector and the industrials sectors are the top two sectors, jointly accounting for ~32% of the total portfolio (more on this in the concluding section of the article).
Does IWM Pay Dividends?
IWM does pay dividends (four times a year) and has been doing so for 21 odd years, but this is nothing to shout home about; admittedly, a large chunk of small-cap stocks are generally in the early stages of their life cycles, and I think it would be unfair to expect them to devote a chunk of their free cash (if they even have any) towards sizeable distributions when they should be rather reinvesting it back into the business; IWM just happens to reflect this unappealing yield landscape.
Regardless, IWM currently only offers a yield of 1.12%, which is below the sector median of 1.39%, and it is also currently lower than the Vanguard Russell 2000 ETF (VTWO), the other notable ETF which tracks the same index as IWM (VTWO currently offers a yield of 1.31%). IWM's dividend growth track record too is rather dispiriting; over the last 3 years, the dividends have only grown at a CAGR of 3%, and over the last 5 years, the CAGR is even less than 2%. Conversely, VTWO's growth rates over the same periods have been much higher at 9.4% and 7%, respectively.
To reiterate IWM's unappealing dividend positioning, one can also consider the yield and growth record of two other popular passively managed small-cap ETF options- a) The SPDR S&P 600 Small Cap ETF (SLY), and b) Schwab U.S. Small-Cap ETF (SCHA). Note that IWM lags both these options (particularly SCHA) when it comes to both the dividend barometers. SLY is the most compelling option both from a yield and growth perspective.
IWM Key Metrics and Performance, Versus Other Notable Options In the Small-Cap Universe
To get a sense of IWM's worth, I've also compared it to the four peers mentioned above (don't expect a drastic difference in the performance numbers of IWM and VTWO as they track the same product).
For ease of comparability, we start from the 20th November 2010, which was the listing date of VTWO (all the other ETFs were set up before that). Since then, IWM has delivered the lowest returns of only 203% whereas something like your SCHA has delivered 1.34x those returns.
Looking at the absolute returns in isolation won't necessarily provide you with a comprehensive understanding of the qualities of these products; to understand that we also need to look at certain risk-adjusted return metrics over both the long-term (10 years) as well as the short-term (3-years).
The first takeaway is that IWM appears to be the most volatile portfolio of this peer set with an annualized standard deviation of 20.2% over the past 10 years, and 28.3% over the past 3 years. Heightened volatility does not necessarily have to be an issue if the ETF can deliver ample excess returns (over the risk-free rate) to compensate for this. Note that none of these ETFs managed to do this, as exemplified by Sharpe ratios of below 1x, but sadly for IWM, its performance is the worst out of the lot, both from a short-term perspective as well as a long-term perspective.
Some would say, the Sortino ratio may be more relevant for the small-cap space given the predilection for ample downside deviation (the Sortino ratio determines the ability of a product to mitigate harmful volatility and deliver excess returns); well even here, IWM puts on a bad show, delivering the lowest Sortino ratios out of the lot.
Structurally, as well do consider that IWM is the least competitive option in this space with an expense ratio of 0.19%, which is well above the other three options, particularly SCHA, which has a minuscule ratio of just 0.04%.
I also want to highlight that IWM tends to be a popular choice for traders who are looking to exploit movements in both directions. Currently, the positioning does not look great as 42% of the total shares outstanding are short; this inordinately high number dwarfs the short-interest figures of the other peers.
Closing Thoughts- Is IWM A Good ETF To Buy?
Even though the markets appeared to have shown some signs of stabilizing over the last few weeks, it would be imprudent to take your foot off the gas and load up on high-beta proxies such as IWM. I still believe that uncertainties around the quantum of central bank hikes, the heightened inflation picture, slowing growth risks, and the Russian-Ukraine impasse could also stimulate fresh bouts of conditions of risk aversion which would be unhealthy for IWM.
Note that on a YTD basis, when the VIX has been up by 43.5%, IWM has underperformed both the S&P 500 (SPY) as well as the Russell 1000 (IWB).
We saw something similar during the first pandemic-induced selling bout in 2020. From the market highs on Feb 20th, 2020 to March 19th, 2020 when the VIX surged by 363%, IWM significantly underperformed the S&P 500 and the Russell 1000 Index. The message is clear; when things are wobbly and uncertain, market participants tend to take refuge in the more prominent large-cap names.
Interestingly, also consider something like earnings potential. Under ordinary circumstances, you would expect small-cap stocks to offer a much superior growth roadmap, but this does not appear to be the case currently. According to YCharts, the constituents of the benchmark - S&P 500 currently offer an expected weighted average earnings growth of 25.6%, whilst the corresponding figure for the constituents of the large-cap-based iShares Russell 1000 ETF is 25.9%. Meanwhile, our ETF in focus-IWM offers a low earnings growth potential of 24.37%, when ideally, you'd expect this figure to be substantially higher than the large-cap focussed options.
What this probably tells you is that these mid and small-cap names of IWM are less favorably positioned to pass on heightened producer prices and mitigate potentially higher interest rates (thus overall lower flow-through to the bottom line). Whereas your large-cap names have the requisite pricing power, customer loyalty, and the balance sheets to mitigate these challenges.
In one of the previous sections of this article, I also highlighted how IWM was something of a cyclically themed ETF with a tilt towards the financials and industrials sections. Well, if we look at how small-cap financials are positioned relative to the total small-cap space, we can see that this ratio no longer looks overextended to the downside, and has in fact, already made up for the weakness seen since the advent of the pandemic in 2020, and is now trading within its historical range of 0.28-0.35.
With small-cap industrials, the risk-reward looks even less appealing, as you can see from the image below, the relative strength ratio of small-cap industrials versus the entire small-cap universe is currently trading well over its range and is close to record-highs. I'm not sure how much upside potential can be extracted under conditions such as these.
Finally, despite all these concerns if you still feel that you'd like to be exposed to the small-cap arena, I reckon other options such as VTWO, SCHA and SLY offer better income angles, are more cost-efficient, and mitigate risk better than IWM (as reiterated in the previous section of the article).
To conclude, IWM does not appear to be a very compelling option to buy and I would rather look at other alternatives. I also wouldn't short IWM and recognize the risk of a short squeeze given the extremely high short interest. The ETF also does not appear to be too far away from dropping into an old congestion zone of $160-170 which could help it form a bottom if it hasn't already. IWM is a HOLD.
This article was written by
The Alpha Sieve
Investment research, primarily oriented towards uncelebrated/under-covered stocks and ETFs, across North America, Europe and Asia. Seeks to combine both fundamental and technical disciplines while making an investment/trading proposition.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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As an enthusiast with a demonstrated understanding of ETFs, particularly the iShares Russell 2000 ETF (IWM), I'd like to provide a comprehensive analysis of the concepts mentioned in the article written by The Alpha Sieve. The depth of my knowledge is based on a keen interest in financial markets, ETFs, and investment strategies.
iShares Russell 2000 ETF (IWM): A Deep Dive
1. Overview of IWM:
- IWM is a passively managed ETF tracking the Russell 2000 Index.
- In existence for over 22 years, it has gathered $55 billion in Assets Under Management (AUM).
- Constitutes a significant portion of the small-cap market.
2. Composition and Benchmark:
- The Russell 2000 Index is a subset of the Russell 3000, capturing the bottom 2000 US public stocks by market cap.
- Represents 98% of all publicly traded US stocks.
- Currently, IWM's portfolio has a skewed representation with 53% in mid-cap, 40% in small-cap, and 6% in micro-cap stocks.
3. Diversification and Concentration:
- IWM is well-diversified with the top 10 stocks accounting for less than 4% of the total portfolio.
- No single sector holds more than 16.5% of the total holdings, indicating a lack of concentration.
4. Dividend Distribution:
- IWM pays dividends quarterly, with a current yield of 1.12%, below the sector median.
- The dividend growth rate over the past 3 and 5 years has been modest, lagging behind competitors like VTWO, SLY, and SCHA.
5. Key Metrics and Performance:
- IWM's historical performance since November 20, 2010, shows it delivering the lowest returns among peers, with 203%.
- Volatility, measured by standard deviation, is higher for IWM, suggesting it is the most volatile among its peers.
6. Expense Ratio and Short Interest:
- IWM has an expense ratio of 0.19%, higher than its competitors, especially SCHA with a ratio of 0.04%.
- A significant concern is the high short interest, currently at 42%, indicating potential bearish sentiment.
7. Market Conditions and Closing Thoughts:
- The article suggests caution in current market conditions, considering factors like central bank hikes, inflation, and geopolitical tensions.
- IWM underperformed during periods of market uncertainty, indicating a preference for large-cap names.
- Earnings potential analysis suggests that IWM's small-cap holdings may face challenges compared to large-cap options.
8. Alternative Recommendations:
- The article concludes by recommending alternative ETFs (VTWO, SCHA, SLY) as potentially better options than IWM.
- Emphasizes income potential, cost efficiency, and risk mitigation as key considerations.
In conclusion, based on the analysis, the author doesn't find IWM to be a compelling investment option given its performance, dividend metrics, volatility, and market conditions. This comprehensive overview provides investors with valuable insights into the potential strengths and weaknesses of IWM as compared to its peers in the small-cap ETF universe.