The Eqwitty Model ETFs (Part 1)

Grab a latte.  We’re going to cover all the funds that make up our Eqwitty Model Portfolios.  No, we are not sponsored or related in any way to iShares or Barclays Global.  It just turns out that iShares offers a great range of core ETF investments that are ideal for low-cost, diversified investing.  A key point to note is that an ETF is an F.  Many forget that when you are investing in a fund or an index you are investing in small fractions of the underlying companies.  Therefore, it is very important to understand the underlying assets you are getting in to when investing in a fund.  After all, you own a tiny bit of a company.  So let’s get started:

iShares S&P 500 Index Fund (IVV)
Indexes are a great way to invest.  Someone does the dirty work for you, trying to find the best possible constituents for their index.  They are going to put they’re name on it after all, so these index keepers want to keep great indexes with well thoughtout requirements and methodologies so they can keep charging iShares and similar ETF issuers licensing fees.

Even if you’re new to investing, you may have already heard of the S&P 500.  It is one of the “Big 3″ indexes generally quoted in media sources.  It is also a standard benchmark by which many actively managed mutual funds and investment advisors measure themselves by.  The Standard and Poor’s 500 is a collection of the 500 leading corporations in the US as determined by S&P’s proprietary methodology.  Its constituents include companies like General Electric, Microsoft, and Chevron. The index symbolizes diversification and to a certain degree symbolizes safety as it represents 75% of the market.  The S&P 500 while considered a broad market index should also be thought of as a Large Cap index as the market cap average is $20.4B and the median company size is $8.7B.

What differs between the iShares S&P and State Street’s SPDR S&P 500 ETF (SPY)?  Very little.  They both sport a very low net expense ratio of 0.09% and “track” the same index.  So why the swing towards iShares?  State Street Global Advisor’s stated expense ratio is 0.10% because of a waiver set to expire at the beginning of next month. In all likelyhood, SSgA will renew the expense ratio waiver, and even if they don’t you probably won’t notice the difference, but like old Abe said, “a penny saved is a penny earned”.

IVV has a 15% allocation in the Eqwitty Aggressive Portfolio and is 10% of the Eqwitty Allocation Portfolio.  It is an excellent core fund for any investment portfolio.

PowerShares FTSE RAFI US 1000 (PRF)
You may have never heard of the alphabet soup fund, but it is quite the delicious offering.  The FTSE Group is an indexing firm jointly owned by the Financial Times and the London Stock Exchange.  They have paired up with Research Affiliates (RA), an investment management firm in Pasadena, CA to create a Fundamental Index (FI).  Get the code now?

There is an inherent flaw with indexing that we don’t have room to get in to here, but we’ll give the basic rundown for now.  Indexes such as the S&P are cap-weighted.  This means the bigger a company is, the greater its representation in the index.  You may have heard the saying that the “bigger they are, the harder they fall”.  In a cap-weighted index, if one of the larger companies in the index takes a big fall, it will have a larger negative impact on the index than if a smaller component took an equal fall.

Does this necessarily always happen?  No.  Leading companies that are the biggest in their industry are often strong enough to hold their market positions and sizes, after all, they did manage to earn their positions in the first place.  But if you have an option such as the FTSE RAFI US 1000 you can reweigh some of your risk.

The FTSE RAFI US 1000 represents the largest 1000 companies based on the fundamental factors of sales, cash flow, book value, and dividends.  While the S&P 500 has more of a “growth” tilt, the RAFI US 1000 has a “value” tilt because of the valuation methodology. If you are unfamiliar with the growth and value “styles” look out for future posts.  PRF has the same weight as the S&P fund to the portfolios, 15% to the Aggressive Portfolio and 10% to the Allocation Portfolio.

iShares Russell Mid Cap Value (IWS)
So with IVV and PRF we already have ourselves a diversified fund of solid American companies.  Do we really need more?  Historically, asset allocation is the greatest contributor to returns, so the answer is: absolutely.  The historical winner for asset classes is Mid Cap Value.  It makes a bit of sense logically.

A mid cap firm is in theory more agile than one of its larger counterparts which may take longer to implement change and is also more agile in the sense that it has room to get bigger.  Compared to its small cap cousins, mid caps have reached a certain size already perhaps by overcoming the many challenges of doing business, and also can better benefit from economies of scale.

Eqwitty is a strong proponent of value investing.  Value > Growth.  End of discussion.  Thus the value tilt you will see in our portfolios and throughout the site.  As a historical outperformer, IWS makes up 20% of the Aggressive Portfolio and 10% of the Allocation Portfolio.

iShares Russell 2000 Value (IWN)
Russell is another widely known indexing firm. Along with their Mid Cap Value index offering, we have also chosen their Small Cap Value index offering.  Small caps are an excellent way to further diversify a portfolio and to extend your reach in to all of the stock market.  The appeal of small caps, like mid caps, is their “agility” as a firm to navigate through industries and also their seemingly limitless ceilings to grow in to.  Add in the fact that everyone loves a good self-made high school dropout American entrepreneur millionaire story.

As a bonus to current economic conditions, small caps have historically added some “oomph” to returns when coming out of a recession.  IWN has a 15% allocation in the Aggressive Portfolio and a 10% allocation in the Allocation Portfolio.

Stay tuned as tomorrow we will cover our International and Fixed-Income ETFs.

Monday, January 05, 2009, 01:10 | posted in the markets | 5 comments »