Mind the Gap: Similar ETFs, Different Returns

At first glance, it’s hard to figure: Two exchange-traded funds follow the same broad class of stocks but beget a huge difference in performance. Both iShares S&P SmallCap 600 (IJR) and iShares Russell 2000 (IWM) track indexes of small firms. But over the past nine years, the S&P SmallCap 600 returned 56 percent, while the Russell 2000 returned 23 percent. Indeed, since 1994 the S&P 600 index has beaten the Russell by, on average, about two percentage points a year, according to a recent study.

Rolf Agather, director of business development at Russell Indexes, doesn’t dispute the study’s findings but argues that his firm’s product is a more accurate picture of the small-cap universe. The firm creates its index out of stocks that aren’t big enough to make it into its large- or midcap universe or small enough for its microcap category. S&P is more selective, says Morningstar ETF analyst Bradley Kay, aiming not just for a representative group of small-cap stocks “but also some of the best companies.” Among other requirements, a company generally must have four consecutive quarters of profits to get into the S&P SmallCap 600.

The performance gap hasn’t stopped the Russell-based ETF from piling up $10.7 billion in assets, more than twice the S&P-based ETF’s assets. That’s partly because institutions often prefer to use the widely followed Russell index. Those who want the broadest exposure to small stocks might want to follow suit. But investors who keep a close eye on total return might let S&P trim the field for them, says Tom Lydon, president of Newport Beach, Calif.–based money-management firm Global Trends Investments.