By Dr. James M. Dahle, WCI Founder
Many stock mutual fund investors are “factor investors.” That means they “tilt” their portfolio toward stocks with certain factors in hopes of achieving higher risk-adjusted returns going forward. The idea is to diversify between different factors or risks rather than just between sectors and different stocks. I have discussed this many times and encouraged those who choose to tilt their portfolios to stay the course even when it seems their tilt is out of favor.
Most recently, I published a post in May 2020 (written earlier) encouraging people to stay the course with their small value tilt, the most common factor tilt, even though it appeared to “not be working” at the time. From the bottom of the market in March 2020 through the rest of 2020, small value outperformed the overall market 85% to 70%. Small value beat the overall market 28.09% to 25.71% in 2021 and even in 2022's cratering market thus far, small value funds with Fidelity and Vanguard have managed to do a little less bad (down 10% vs 18% as of 5/25/22) than the rest of the overall market.
The purpose of today's post is not to debate whether you should tilt your portfolio to small and value. If you want to read more about that, try these posts:
- What About Value Investing?
- Understand What You Own
- Larry Swedroe's Factor Investing Book
- Rick Ferri vs. Paul Merriman on Factor Investing
- Evidence-Based Investing with Larry Swedroe
Instead, we're going to talk about what vehicle you should use if you choose to tilt your portfolio to small and value.
What Small Value ETF Funds I Have Used
My records show that the first time I bought a share of a small value fund was in July 2007. I've been a big fan of Vanguard since I became financially literate more than 15 years ago, so I've always used the Vanguard Small Value Index Fund (VSIAX for the traditional mutual fund, VBR for the ETF version) for this tilt. I've always been aware it was neither the smallest nor the most valuey of small value funds. But the cost was very low, and it was well-diversified. It served my purposes. If I wanted more tilt to the portfolio, I could just add more of it. The big debate back then was whether it was worth paying an investment advisor to get access to the Dimensional Fund Advisors' (DFA) small value fund, which was smaller and more value-y. I wrote about that back in 2013 and, in fact, actually use both of them in my childrens' 529s:
Now, more and more investors are using ETFs rather than mutual funds. Aside from the unique Vanguard Fund/ETF structure, ETFs are a little more tax-efficient than traditional funds, and they can be purchased at any brokerage for minimal cost. Since we have money spread across Schwab, Fidelity, and Vanguard brokerages (not necessarily by choice), using ETFs allows us to use the same fund in each place. The explosion of ETFs has created numerous additional options for small value investors, so I thought it was time for me to take a look at my fund choice again. As a reminder, our overall portfolio asset allocation looks like this:
Stocks/Bonds/Real Estate: 60/20/20
- US Total Stock Market: 25%
- US Small Value: 15%
- Total International Stock Market: 15%
- International Small: 5%
- TIPS: 10%
- Nominal Bonds: 10%
- US REITs: 5%
- Equity Real Estate: 10%
- Debt Real Estate: 5%
Since small value makes up as much of the portfolio as all of my private real estate holdings, it seems worthwhile to spend some time on this decision. Plus, as our taxable to tax-protected account ratio rapidly grows, we're now having to move small value stocks into our taxable account (along with TSM, TISM, IS, nominal bonds, and real estate). So, we now need tax-loss harvesting partners, i.e. ETFs that we're just as comfortable holding long-term as our original choice. Is VBR really still the best choice for us?
Small Cap Value ETF Options
Let's go through each of the reasonable options one by one and discuss their various merits. We'll start with this overview chart comparing small value ETFs (you can click on the image below to make it larger). Note that I am only looking at ETFs, not traditional mutual funds. If you are willing to look at funds too, be sure to look at the DFA and Fidelity options in addition to these eight ETFs.
#1 VBR
Unlike the other options in this list, the Vanguard Small Value Index Fund is available as a traditional mutual fund (VSIAX, started in 1998) or as an ETF (VBR, started in 2004). It boasts a very low expense ratio at just seven basis points. That's not quite free, but it is very close. As you can see, it is not a 100% small value fund. None of these ETFs are, but this one is less so than any of the others. There is a fair amount of both mid-caps and “blend” stocks. In fact, this is what draws most of its criticism—it isn't small or value-y enough for some people's taste. Personally, I appreciate its low costs and liquidity and Vanguard's demonstrated ability to closely track an index over long periods of time.
#2 VIOV
Unlike its mutual fund lineup, the Vanguard ETF lineup includes three small value index funds. The Vanguard S&P Small Cap 600 Value ETF (VIOV), founded in 2010, is not as old as VBR (2004), but it has become a worthy alternative. It is significantly smaller than VBR and slightly more value-y. It only has half as many stocks, so it is less diversified. It is also dramatically less liquid. Even Vanguard tries to steer you away from this ETF and in to VBR:
VIOV is what we use in our taxable account as a tax loss harvesting partner for VBR.
#3 VTWV
The third small value ETF in the Vanguard lineup was started at the same time as VIOV (2010), but it follows a different index—the Russell 2000 Value Index. This fund offers more diversification than either of the above funds with 1,434 stocks, but that's about the last good thing I can say about it. It is about as small as VIOV but slightly less value-y. It has about the same liquidity, it costs about the same, and it has just as much trouble tracking its index closely. However, despite a very similar make-up, its performance over the last 10 years is dramatically worse, about 1.5% worse than VIOV and VBR. I don't know what it is about Russell indexes, but the performance of index funds that track them never seems to be very impressive to me.
#4 IJS
Moving from Vanguard over to Blackrock's iShares, we come to the iShares S&P Small Cap 600 Value ETF. This tracks the same index as VIOV above, but it charges a little more and seems to have more trouble tracking its index. Still, it is the best performing option in this asset class over the last 10 years.
This ETF was formed in 2000 and, thus, is one of the granddaddies among small value ETFs. The major benefit of IJS over VIOV is simply liquidity, but I'm not sure I'd give that up in exchange for such difficulty tracking its index, at least up until the last five years. This indexing stuff doesn't seem to be that hard, but this particular ETF sure seems to struggle with it (though the last year has seen the 10-year tracking error drop from 0.65% to 0.19%).
#5 IWN
This second offering from iShares follows the Russell 2000 Value Index, similar to VTWV. It has great liquidity (it is the most liquid of these eight ETFs), and it does a better job tracking its index than IJS does. Maybe the problem is its index. Like IJS, this ETF was formed in 2000. Despite its massive liquidity, it is still significantly more expensive than its Vanguard counterparts with an expense ratio of 0.24%. In fact, given the higher ER, it is impressive that its long-term tracking error is so similar.
#6 SVAL
This is a brand-new ETF without a significant track record. It is one of the least diverse of the small value ETFs with just 285 holdings. That is by design, as it tracks an index that has just 250 holdings. The Russell 2000 Focused Value Select Index is supposed to be an improvement on all of the above indexes. It is slightly smaller and significantly more value-y. Its one-year return is 2.79%, and its one-year tracking error is 0.22%.
It's a little bit DFA-like, passive but with rules that are supposed to beat traditional indexing techniques. I'm a little skeptical. Given its very short track record and the fact that it trusts Russell to make a decent index, I think I'll hold off on this choice for a few years. Interestingly, it's already twice as liquid as two of the three Vanguard ETFs.
#7 SLYV
This is SPDR's answer to VIOV and IJS. Actually, it's been around just as long as IJS and a decade longer than VIOV. It is cheaper and almost as liquid as IJS, but it shares the same trouble tracking its index (although more recently, it seems to be doing better with this).
#8 RZV
Here is a fairly unique ETF, designed for those who think that even the S&P Small Cap 600 Value and the Russell 2000 Value indexes aren't value-y enough for their taste. The Invesco S&P 600 Small Cap 600 Pure Value ETF follows its namesake index, the S&P Small Cap 600 Pure Value index, and as you can see, it is even more value-y.
If you want small value, this is small value. But look what you have to give up to get it. You have to give up diversification (only 172 stocks compared to 285-1,400 in the other ETFs), you have to give up additional expenses (0.35% vs. 0.07-0.20%), you have to give up liquidity (it's the least liquid of the ETFs), and you still have significant tracking errors. Some years that tracking error is pretty small, but in other years, it is as high as 0.79%.
How to Choose an ETF
When choosing an index fund to represent an asset class in your portfolio, there are really only two questions that you need to answer.
#1 Which Index?
This decision is really looking at what does the fund invest in. When it comes to styles or factors, this matters a lot more than with total market index funds. The methodology of deciding what a small company is and what a value company is affects performance.
#2 How Well Does the Fund (or ETF) Track It?
It turns out there is some skill required to track an index, and some people and companies are better at it than others. The price definitely matters but should be built in to the tracking error. Most funds lend securities to short sellers, and this has the potential to make up for a significant portion of a fund's expense. But only some companies (like Vanguard and Fidelity) pass all of the income from those activities back to the shareholders. iShares only passes back 75%-82% of that income to shareholders. Invesco passes back 90%.
When looking at these eight ETFs, they can really be broken down into five groups based on the index they track.
- CRSP Small Value Index (VBR)
- S&P Small Cap 600 Value (VIOV, IJS, SLYV)
- S&P Small Cap 600 Pure Value (RZV)
- Russell 2000 Value (VTWV, IWN)
- Russell 2000 Focused Value Select index (SVAL)
As you would expect, the Russell 2000 tracking ETFs have almost the exact same 10-year returns. Which makes what has happened with the S&P Small Cap 600 Value tracking ETFs 5-15 years ago all that much more bizarre. Take a look at this chart that was put together just before the market began to crater at the beginning of 2022:
I mean, what in the world? The only good news there is that it seems they're all getting better at doing this indexing thing in the last five years.
I find the S&P 600 Index to be intriguing and attractive. Given how large growth has outperformed small value over the last decade, I would have expected these ETFs to have underperformed VBR over that time period, like the Russell 2000 Value tracking ETFs and, most impressively, RZV. But they didn't, despite being smaller and more value-y.
I am also curious to see how SVAL does over the next few years, but its track record is just too short for me to be willing to bet on it.
Best Small Cap Value ETF
Your good options here are three-fold:
#1 The Case for VBR
I still think VBR is the best choice for me. It is liquid, diverse, very low cost, and it tracks its index well. The only beef anyone has with it is that it isn't as small and value-y as the other ETFs. An easy solution is to simply hold more of it. If you wanted 10% of your portfolio in something like RZV or VIOV, then just put 12% or 15% into VBR and call it good.
#2 An S&P Small Cap 600 Value Tracking ETF
If VBR isn't good enough for you, these three ETFs offer a solid option at a reasonable cost. If minimal tracking error matters most to you, then go with VIOV. If liquidity matters more, then go with IJS or SLYV. Either way, any of these three ETFs make for excellent tax loss-harvesting partners for VBR. Are they substantially different from each other to use as tax-loss harvesting partners? Well, the IRS has a strong argument that they're substantially identical since they all follow the same index. But let's be honest, the CUSIP is different, so nobody really cares. I still have yet to meet someone who was audited on this particular point. VIOV is the obvious tax-loss harvesting partner for me given my primary holding of VBR.
#3 RZV
This one is for the purists out there. If getting the smallest and most value-y ETF is what you want, this is for you. It has serious liquidity and diversification issues, however. I'm just not willing to put 15% of my portfolio into just 172 of the riskiest companies in the market.
What do you think? Do you use a small value ETF? Which one and why? If you had to tax-loss harvest, which one would you go to? Comment below!
I wish you’d have included AVUV. If I understand correctly they have the same philosophy as DFA, but made it available in etf form which DFA wasn’t doing back then.
I agree. Paul Merriman recommends AVUV over SLYV , and Larry Swedroe frequently compares AVUV to TSM or other benchmarks. Not to mention, it’s more tax-efficient because it excludes REITs.
Hindsight might reveal it was performance chasing, but for .10 extra ER, I’m glad I’ve been putting all my new funds into AVUV instead of SLYV since 2021.
I guess I should have. First four comments talking about it.
Hard to decide when to call it actively managed though. Excludes REITs, profitability screen etc. Maybe if I did a post about “which small cap value profitability funds are best for you” it would be at the top of the list.
It’s also less than 3 years old. Not much of a track record.
DFA also now has a small cap value ETF (DFSV), has a short track record but it should have a similar methodology to their mutual fund DFSVX. I personally hold Avantis instead of DFA for a number of reasons, but their methodologies stem from the same research (although they are fairly different).
anything that tracks the s&p 600 has a probability screen. s&p does not track nonprofitable stocks.
most people on the bogleheads forum, as of lately, advocate for avuv for usa small cap value since it’s inception, as it screens out for small-cap growth stocks with aggressive investment strategies, which have historically been the black hole of investing or the stocks that generate the lottery like returns.
avdv is the most bang for your buck for developed markets international value.
the dimensional fund counterparts are equally good for a couple more basis points as TLH partners. if you run these funds comparatively to vbr, you will see they’re much more valuey and have a much smaller average market cap.
Things trend on the Bogleheads forum. Stick around for a few years and there’ll likely be something else preferred.
I agree there are other funds/ETFs that are more valuey or smaller. I’m not convinced that actually makes them better than just holding more of something that is less valuey and larger.
I also currently use AVUV (ER=0.25). Very small, very value-y, liquid enough, cheap enough, and extremely tax efficient (b/c it excludes REITs from its rules based ‘index’). CRSP and S&P 600 indices hold 5-10% REITs making the index funds less efficient in a taxable account. AVUV also performs a profitability screen before including a company—similar to the S&P 600 index.
So AVUV seems to blend the best of everything I’m looking for in a fund.
Sadly, I’m now in need of a tax harvest partner for small cap value. I’m looking at:
DFAT (ER=0.29, DFA reputation, highly liquid, but not as small/value-y), or
DFSV (ER=0.31, DFA reputation, smaller and more value-y, but newer so not as liquid).
Too many choices……. Analysis paralysis. Ugh.
What did you end up deciding on as a TLH pair?
What do you think of VFVA? Ive got a long horizon (in residency) and am thinking of adding factor tilting to my portfolio. It seems like a good option for value investing across all caps. Not sure if its worth the higher ER/ lack of track record compared to VBR though
I use Avantis, e.g. AVUV.
They are more “small” & more “value” than Vanguard’s small value options.
Appreciate the post Dr Dahle!
I would also appreciate your take on AVUV and DFSV (and related international funds such as AVDV & DISV). The S&P 600 Value Index is actively managed by S&P and has fewer holdings than both AVUV and DFSV. Both are new, but the first has a few years to show now with reasonable performance, and the later is by DFA and expected to be similar to their well-established small-cap value mutual fund (DFSVX). To me it seems like either is likely a good choice based on high factor loading, ability to emphasize profitability & frequent reconstitution with avoidance of index front-running (e.g., less impact from things like the GME/Gamestop drama). Admittedly with small increase in costs. This seems like an area of active debate issue at Bogleheads & Rational Reminder without real consensus. Perhaps, to paraphrase something Gene Fama might say, it is all a matter of “taste.”
Thanks for all you do.
Both are reasonable choices. Keep in mind there is not THAT much difference between all of these. Not sure Gamestop had much effect on small value funds. More on DFA vs Vanguard here and I think much of what is written applies to ETFs as much as funds.
https://www.whitecoatinvestor.com/dfa-vs-vanguard/
Thank you.
Jim, I recognize this article is about ETFs only but thoughts about VTMSX for placement in a taxable account? Thanks.
Well, it’s not small value it’s just small.
I’ve never been a huge fan of Vanguard’s tax managed funds in general. They’re not a lot more tax efficient than the bread and butter index funds so I generally use those instead. But you can obviously do a lot worse than using them.
Incredible article. I found the bogleheads forum recommending ISCV (iShares morning star small-cap value, ER 0.06).
Similar costs to VBR. Do you have thoughts on this? I don’t think it was mentioned. Thank you!
Big fan of iShares. Guess I should have mentioned that one too. Maybe I didn’t realize iShares had two SCV ETFs when I was writing this post many months ago. It’s a little bigger than IJS, but about as valuey. There are a lot more stocks in it. The expense ratio is lower too. Seems like a very reasonable choice.
Hi Jim,
I’m trying to decide which US small value fund/etf to use in my Fidelity HSA. Fidelity allows investing in iShares ETFs without commission, so I’m deciding between Fidelity’s small value index fund (FISVX; expense ratio 0.05%) which follows the Russel 2000 index and iShares small cap 600 value ETF (expense ratio 0.18%). You noted above that you’re a big fan of iShares, but you also stated that, “iShares only passes back 75%-82% of that income to shareholders” when discussing how well funds/etfs track their indices and how they lend securities to short sellers, whereas Fidelity passes all the income back to investors. Considering this point, and the differences in expense ratios, the indices tracked, and the fundamental differences between mutual funds and ETFs, which do you think would be the better choice for long-term investing in an HSA?
Appreciate your insight,
Tom
Doesn’t matter much. But in general, my first choice is Vanguard for mutual funds/ETFs, especially in taxable. I tax loss harvest into iShares ETFs, but Vanguard is my first choice. In tax protected accounts like HSAs, it really doesn’t matter much.
When it comes down to SV, there’s lot of disagreement out there. I tend to use VBR with VIOV as a tax loss harvesting partner, but I don’t know that I can make a super convincing argument for either over every other choice out there. The important differences here are primarily which index is being tracked. Most funds track the S&P 600 small cap value index but I’m not sure I love that one.
Thanks so much for this article. I’ve been trying to compare some of these funds myself and this is incredibly helpful. What resource did you use to determine the percentage of small or value tilt within the fund?
That’s a great question. I’m not sure I remember. (I know this was just published, but I wrote it over a year ago). I think just Morningstar.
I’ve been a long-time fan of small-value funds (I’ve held one since some time in the 1990s, so I’ve seen plenty of ups and downs, but generally have been pleased), so I found this especially interesting. One question: What source did you use for tracking error? I found this one, and wanted to see if that’s where your data came from. Thanks. https://www.trackinsight.com/en/fund/VBR
No, but looks like a good resource.
I think I simply used the reported difference between their index return and their actual return on morningstar now that I think about it.
Really want a second article or addendum discussing DFSV / DISV & AVUV / AVDV. Would like your take on both companies offerings and how to split the percentage of SCV between US / INT.
Not a superfan of the DFA/Avantis methodologies to add value. I suspect much of what they’re adding is lost in the additional fees. But they’re fine. They’re not bad funds.
As far as how much to tilt….don’t tilt more than you believe and can maintain belief through decades of underperformance.
great article Jim. What are your thoughts on fidelity’s small cap value index fund, FISVX? I chose it simply because its the lowest ER of any small cap value index I could find and I was only putting small cap value in my Roth so I didn’t need an ETF. also seems to be pretty small and valuey.
also, do you think that that the extra expense ratio is worth having a more small and valuey fund? or do you think Bogle trumps Fama in that costs matter, and that we are not sure if and when a more small valuey premium will appear in the future, but low costs are guaranteed better return?
Seems a reasonable choice.
How much small value tilt is right is anyone’s guess. Don’t tilt more than you believe. I think a tilt is worth the additional cost, how much? Anyone’s guess.
Thanks for the article! One thing I’d quibble with: you differentiate the 3 S&P600 ETFs based on liquidity, which I’m guessing is based on some combination of average volume & spreads. I’d disagree with that assertion–at the end of the day, the liquidity of an ETF is based on the underlying holdings (which they all have in common). One of the biggest benefits of the ETF structure is that you’re not restricted to the visible liquidity in the secondary market like you are with most other securities. An authorized participant can alter the number of shares as needed in-kind, so someone could place a market order for >10x the total average daily volume of an ETF like VIOV and it’d still get instantly filled at the current visible market price. (You can occasionally see examples of that on low-volume ETFs when you look through their historical trading volume.)
That’s a good point, although I’m not certainly how often that liquidity option is used.
I have been digesting as much of your stuff as possible over the last few months. I am in the process of doing my AA but the small value is causing me issues. I want to put 15% of my portfolio in there, however my 401k has only 1 real option and that is the BlackRock Russell 2000 Index. What are your opinions on this one? I am able to get almost everything else I want but this is causing me some issues.
Do you have other investing accounts besides the 401(k)? (Roth IRA, taxable etc?) Why not put the SV there? A Russell 2000 index fund is small cap, but not small value.
Thanks for the reply. I have an HSA, and Roth IRA that I can get it in. The problem is my options are limited on what to get in my 401k. My plan does allow in service rollovers, but I am still left with 21% of my portfolio in my 401k. We have 4 large cap funds (BLKRK EQUITY INDEX,SP TTL MRKT IDX CL E, VPMAX, and VWNAX) , 1 mid cap, 1 small cap (the one I posted), 3 int funds (SS GACEQ EXUS IDX II, VANG INTL GROWTH ADM (VWILX), and VANGUARD INTL VALUE (VTRIX)). The fees on the int funds are at least 3 times higher than VTIAX. My gut says to use the Spartan fund for my total stock market allocation. Thoughts?
I’m lost. How much small value do you want in your portfolio that you have to have some in your 401(k) even though it is only 21% of your portfolio?
I’d just use what’s good in the 401(k) and build around that. Maybe that means your entire 401(k) is in that low cost total market index fund and your other asset classes are elsewhere in the portfolio.