Growths ETFs the New Value?

Value has beaten growth almost every year for a decade. Growth ETFs are funds that hold companies which grow their earnings faster than the average rate. Because investors expect quicker growth, these companies tend to be more expensive in terms of earnings and book value. But the price of this growth has fallen dramatically in recent years. Are growth ETFs the new value funds?

Mean reversion suggests that prices and returns eventually move back to the average. The longer growth parperforms or underperforms value, and the relatively more expensive value becomes, the more likely that growth will once again outshine. Growth ETFs have holdings in the most dynamic and successful companies with strong opportunities for growth-- particularly in a rebounding economy.

iShares Russell 1000 Growth Index (NYSEArca:IWF) is one of the best established growth ETFs with over 10 billion in assets. iShares Russell 1000 Value Index (NYSEArca:IWD) is almost as large. Currently, IWF has a Price/Earnings ratio of 16. IWD has a P/E ratio of 14. This tight (less than 10%) difference reflects the similarity of the two groups pricing in the current environment.

The chart below compares the 10-year performance of growth ETF IWF and value fund IWD:

The chart shows that the most dramatic divergence of growth and value happened between 2000 and 2003, as the tech-driven markets of the 1990s unwound. Prior to this (during the dot com boom) the cost of growth in comparison to value soared and the P/E ratio of growth companies expanded. As the dot com bubble heated up investors in some growth funds poneyed up more than three times as much for than for value.

There are different ways of defining growth and standard criteria for stock selection. For some portfolios expected long term average growth-to-value P/E ratio is 1.5 (growth stocks having a P/E of about 1.5 times value). In the late 1990s, this ratio increased, reaching its height in 2000 before collapsing lower on a trend that remains largely intact today. The chart below, based on data from Fidelity through 2009, shows this.

The heavy line in the chart marks the long-term P/E ratio of 1.5 growth to value. In 2000 the ratio jumped briefly to more than 3 times value. The current level is below this historic average.

Part of the reason for the relative underperformance of growth is the general slowdown in the U.S. equity markets over the past decade. Also, growth ETFs typically pay lower dividends. IWD's dividend is currently over 50% higher than IWF. Although this amounts to little over 100 basis points, in a slow growth environment of low interest rates, every basis point counts.

The underperformance of growth over the last decade recalls research by Fama and French published in the mid 1990s. In their study Fama and French panned growth stocks. They suggested that growth over the longer term delivers lower returns at higher risk than value funds. (They also singled out small cap growth as an especially unwelcome asset class, both volatile and low performing.) Ironically, no sooner than they finished their study, growth stocks when on an extended run, far outperforming value. Since then the trend has once again reversed.

There a many types of growth ETFs, including fundamental funds, leverage funds and short ETFs that are useful for traders. The plain vanilla growth funds are differentiated primarily in terms of the market cap size of their holdings and their exposure to small companies. Growth investors who wish to overweight a range of certain sized growth companies should find an ETF that matches that range. The list below presents traditional growth ETFs, the company size targeted in their holdings, as well as their fees:

Traditional "Plain Vanilla" Growth ETFs

* iShares Russell 1000 Growth ETF (NYSEArca:IWF): 1000 largest firms, .20%/ year fees

* iShares Russell 2000 Growth ETF (NYSEArca:IWO): 1001-2000 largest firms, .25%

* iShares Russell 3000 Growth ETF (NYSEArca:IWZ): 3000 largest firms, .25%

* iShares Russell Midcap Growth ETF (NYSEArca:IWP): 201-1000 largest firms., .25%

* iShares S&P 500 Growth ETF (NYSEArca:IVW): 500 largest firms, .18%

* iShares S&P MidCap 400 Growth ETF (NYSEArca:IJK): 501 to 900 largest, .25%

* iShares S&P SmallCap 600 Growth Index Fund (IJT): 901 to 1500 largest, .25%

* SPDR Dow Jones Wilshire Large Cap Growth ETF (NYSEArca:ELG): largest 750, .20%

* SPDR Dow Jones Wilshire Mid Cap Growth ETF (NYSEArca:EMG): 501-1000 largest, .25%

* SPDR Dow Jones Wilshire Small Cap Growth ETF (NYSEArac:DSG): 751-2500 largest, .25%

* Vanguard Growth ETF (NYSEArca:VUG): 750 largest firms, .11%

* Vanguard Mega Cap 300 Growth ETF (NYSEArca:MGK): 300 largest firms, .13%

* Vanguard Mid-Cap Growth ETF (NYSEArca:VOT): 301-750 largest firms, .13%

* Vanguard Small-Cap Growth ETF (AMEX:VBK): 751-1750 largest, .12%

* Rydex S&P 500 Pure Growth ETF (NYSEArca:RPG), 500 largest firms, .35%

* Rydex S&P MidCap 400 Pure Growth ETF (NYSEArca:RFG), 501-900 largest, .35%

* Rydex S&P SmallCap 600 Pure Growth ETF (NYSEArca:RZG), 901-1500 largest, .35%

* iShares Morningstar Large Growth Index Fund (NYSEArca:JKE), .3%

* iShares Morningstar Mid Growth Index Fund (NYSEArca:JKH), .3%

* iShares Morningstar Small Growth Index Fund (NYSEArca:JKK), .3%

* PowerShares Autonomic Balanced Growth NFA Global Asset Portfolio ETF (NYSEArca:PAO), .25%

* PowerShares Autonomic Growth NFA Global Asset Portfolio ETF (NYSEArca:PTO), .25%

Fundamental Growth ETFs

There are also several ETFs based on proprietary enhanced or fundamental indexes. These funds sometimes deliver higher returns, sometimes lower. They always charge higher fees.

* First Trust Large Cap Growth Opportunities AlphaDEX Fund (NYSEArca:FTC), .7%

* Powershares Dynamic Large Cap Growth Portfolio ETF (NYSEArca:PWB), .63%

* Powershares Dynamic Mid Cap Growth Portfolio ETF (NYSEArca:PWJ), .63%

* Powershares Dynamic Small Cap Growth Portfolio ETF (NYSEArca:PWT), .63%

And finally there are short and leverage growth ETFs suitable for speculative traders looking for a short-term play:

Short/Leverage Growth ETFs

* ProShares Ultra Russell 1000 Growth ETF (NYSEArca:UKF), .95%

* ProShares Ultra Russell 2000 Growth ETF (NYSEArca:UKK), .95%

* ProShares Ultra Russell MidCap Growth ETF (NYSEArca:UKW), .95%

* ProShares UltraShort Russell 1000 Growth ETF (NYSEArca:SFK), .95%

* ProShares UltraShort Russell 2000 Growth ETF (NYSEArca:SKK), .95%

* ProShares UltraShort Russell MidCap Growth ETF (NYSEArca:SDK), .95%