ITOT: Why Market-Cap Weighting Isn't Optimal For Total Market ETFs

seekingalpha07-10

ITOT is a low-cost total market fund representing approximately 4,000 U.S. securities. It's marketed to passive investors and has $58 billion in assets under management with a 0.03% expense ratio.ITOT...

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It's marketed to passive investors and has $58 billion in assets under management with a 0.03% expense ratio.ITOT...</p>\n\n<a href=\"https://seekingalpha.com/article/4703179-itot-why-market-cap-weighting-isnt-optimal-for-total-market-etfs\">Source Link</a>\n\n</div>\n","source":"seekingalpha","html":"<!DOCTYPE html>\n<html>\n<head>\n<meta http-equiv=\"Content-Type\" content=\"text/html; charset=utf-8\" />\n<meta name=\"viewport\" content=\"width=device-width,initial-scale=1.0,minimum-scale=1.0,maximum-scale=1.0,user-scalable=no\"/>\n<meta name=\"format-detection\" content=\"telephone=no,email=no,address=no\" />\n<title>ITOT: Why Market-Cap Weighting Isn't Optimal For Total Market ETFs</title>\n<style type=\"text/css\">\na,abbr,acronym,address,applet,article,aside,audio,b,big,blockquote,body,canvas,caption,center,cite,code,dd,del,details,dfn,div,dl,dt,\nem,embed,fieldset,figcaption,figure,footer,form,h1,h2,h3,h4,h5,h6,header,hgroup,html,i,iframe,img,ins,kbd,label,legend,li,mark,menu,nav,\nobject,ol,output,p,pre,q,ruby,s,samp,section,small,span,strike,strong,sub,summary,sup,table,tbody,td,tfoot,th,thead,time,tr,tt,u,ul,var,video{ font:inherit;margin:0;padding:0;vertical-align:baseline;border:0 }\nbody{ font-size:16px; line-height:1.5; color:#999; background:transparent; }\n.wrapper{ overflow:hidden;word-break:break-all;padding:10px; }\nh1,h2{ font-weight:normal; line-height:1.35; margin-bottom:.6em; }\nh3,h4,h5,h6{ line-height:1.35; margin-bottom:1em; }\nh1{ font-size:24px; }\nh2{ font-size:20px; }\nh3{ font-size:18px; }\nh4{ font-size:16px; }\nh5{ font-size:14px; }\nh6{ font-size:12px; }\np,ul,ol,blockquote,dl,table{ margin:1.2em 0; }\nul,ol{ margin-left:2em; }\nul{ list-style:disc; }\nol{ list-style:decimal; }\nli,li p{ margin:10px 0;}\nimg{ max-width:100%;display:block;margin:0 auto 1em; }\nblockquote{ color:#B5B2B1; border-left:3px solid #aaa; padding:1em; }\nstrong,b{font-weight:bold;}\nem,i{font-style:italic;}\ntable{ width:100%;border-collapse:collapse;border-spacing:1px;margin:1em 0;font-size:.9em; }\nth,td{ padding:5px;text-align:left;border:1px solid #aaa; }\nth{ font-weight:bold;background:#5d5d5d; }\n.symbol-link{font-weight:bold;}\n/* header{ border-bottom:1px solid #494756; } */\n.title{ margin:0 0 8px;line-height:1.3;color:#ddd; }\n.meta {color:#5e5c6d;font-size:13px;margin:0 0 .5em; }\na{text-decoration:none; color:#2a4b87;}\n.meta .head { display: inline-block; overflow: hidden}\n.head .h-thumb { width: 30px; height: 30px; margin: 0; padding: 0; border-radius: 50%; float: left;}\n.head .h-content { margin: 0; padding: 0 0 0 9px; float: left;}\n.head .h-name {font-size: 13px; color: #eee; margin: 0;}\n.head .h-time {font-size: 11px; color: #7E829C; margin: 0;line-height: 11px;}\n.small {font-size: 12.5px; display: inline-block; transform: scale(0.9); -webkit-transform: scale(0.9); transform-origin: left; -webkit-transform-origin: left;}\n.smaller {font-size: 12.5px; display: inline-block; transform: scale(0.8); -webkit-transform: scale(0.8); transform-origin: left; -webkit-transform-origin: left;}\n.bt-text {font-size: 12px;margin: 1.5em 0 0 0}\n.bt-text p {margin: 0}\n</style>\n</head>\n<body>\n<div class=\"wrapper\">\n<header>\n<h2 class=\"title\">\nITOT: Why Market-Cap Weighting Isn't Optimal For Total Market ETFs\n</h2>\n\n<h4 class=\"meta\">\n\n\n2024-07-10 00:04 GMT+8&nbsp;&nbsp;&nbsp;<a href=https://seekingalpha.com/article/4703179-itot-why-market-cap-weighting-isnt-optimal-for-total-market-etfs><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>ITOT is a low-cost total market fund representing approximately 4,000 U.S. securities. It's marketed to passive investors and has $58 billion in assets under management with a 0.03% expense ratio.ITOT...</p>\n\n<a href=\"https://seekingalpha.com/article/4703179-itot-why-market-cap-weighting-isnt-optimal-for-total-market-etfs\">Source Link</a>\n\n</div>\n\n\n</article>\n</div>\n</body>\n</html>\n","isBrief":false,"type":0,"news_type":1,"symbol":"SFLO","symbol_name":"VICTORYSHARES SMALL CAP FREE CASH FLOW ETF","start_time":0,"source_url":"https://seekingalpha.com/article/4703179-itot-why-market-cap-weighting-isnt-optimal-for-total-market-etfs","article_id":"2450203530","we_media_id":null,"thumbnails":["https://static.seekingalpha.com/cdn/s3/uploads/getty_images/668600179/image_668600179.jpg"],"rights":null,"url":"https://stock-news.laohu8.com/highlight/detail?id=2450203530","pubTimestamp":1720541043,"sourceInfo":{"source_id":"seekingalpha","name":"Seeking Alpha"},"weMediaInfo":null,"summary":"ITOT is a low-cost total market fund representing approximately 4,000 U.S. securities. It's marketed to passive investors and has $58 billion in assets under management with a 0.03% expense ratio.ITOT","collect":0,"end_time":0,"defaultTopTitle":"seekingalpha.com","property":[],"viewcount":null,"language":"en","relate_stocks":{"SFLO":"VICTORYSHARES SMALL CAP FREE CASH FLOW ETF","BK4559":"巴菲特持仓","FDN":"First Trust Dow Jones Internet I","SPSM":"SPDR Portfolio S&P 600 Small Cap ETF","OEX":"标普100","VOO":"Vanguard标普500ETF","SPTM":"SPDR Portfolio S&P 1500 Composite Stock Market ETF","VTI":"大盘指数ETF-Vanguard MSCI","BK4581":"高盛持仓","SMCF":"THEMES US SMALL CAP CASH FLOW CHAMPIONS ETF","ITOT":"安硕核心标普全美股市ETF-iShares","SPY":"标普500ETF","IVV":"标普500指数ETF","DSMC":"Distillate Small/Mid Cash Flow ETF","SDS":"两倍做空标普500ETF","FLQM":"Franklin U.S. Mid Cap Multifactor Index ETF","SCHB":"Schwab US Broad Market ETF","SCHA":"Schwab US Small-Cap ETF","BK4504":"桥水持仓","RSP":"平均加权指数ETF-Rydex S&P","SPXU":"三倍做空标普500ETF","BK4585":"ETF&股票定投概念","SPLV":"Invesco S&P 500 Low Volatility ETF","OEF":"标普100指数ETF-iShares","SH":"标普500反向ETF","SMLF":"iShares U.S. Small Cap Equity Factor ETF","PSC":"Principal U.S. Small-Cap Multi-Factor ETF","UPRO":"三倍做多标普500ETF","SSO":"两倍做多标普500ETF","BK4534":"瑞士信贷持仓","BK4550":"红杉资本持仓",".SPX":"S&P 500 Index","BK4588":"碎股"},"translate_title":"ITOT：为什么市值权重对于总市场ETF来说不是最佳选择","themeId":null,"isJumpTheme":false,"ttsUrl":null,"symbols_score_info":{"RSP":1,"VTI":1,"SPY":1,"SPTM":1,"SPSM":1,"SPLV":1,"SMLF":1,"SMCF":1,"SFLO":1,"SCHB":1,"SCHA":1,"PSC":1,"FLQM":1,"DSMC":1,"ITOT":1,"VOO":0.9,"FDN":0.9,"UPRO":0.6,"SSO":0.6,"SPXU":0.6,"SH":0.6,"SDS":0.6,".SPX":0.6,"ESmain":0.6,"OEX":0.6,"OEF":0.6,"IVV":0.6},"content_text":"ITOT is a low-cost total market fund representing approximately 4,000 U.S. securities. It's marketed to passive investors and has $58 billion in assets under management with a 0.03% expense ratio.ITOT's market-cap-weighting scheme is a weakness. While this works well for the large-cap segment, small and mid-cap investors are better served by factor funds that emphasize quality.The weakness appears when analyzing ITOT and SPY fundamentally. There is minimal or no improvement in growth and valuation, but quality takes a hit. This helps explain recent underperformance.I recommend separating your large, mid, and small-cap funds into three ETFs to replicate ITOT's composition. SPY is an excellent core holding, and this article provides suggestions for the remainder.Matteo Colombo Investment Thesis I last reviewed the iShares Core S&P Total U.S. Stock Market ETF (NYSEARCA:ITOT) on July 10, 2023, highlighting how its slightly better diversification compared to the SPDR® S&P 500® ETF Trust (SPY) came at the significant expense of quality. Based on this observation, I concluded readers should avoid ITOT. Since that article was published, it's lagged behind SPY by 1.78% on total returns. Seeking Alpha Today's article provides an update on ITOT's fundamentals and predicts whether this trend will continue. I will also look at the other three total market funds listed above and provide suggestions on factor-driven small- and mid-cap funds you might consider adding to SPY to improve returns. I hope you enjoy the read. ITOT Overview Strategy Discussion ITOT tracks the S&P Total Market Index, providing float-adjusted market-cap-weighted exposure to over 4,000 U.S. securities. Many of these securities aren't very liquid, so ITOT employs a statistical sampling method and currently holds approximately 2,500 securities. The Index rebalances quarterly in March, June, September, and December, and ITOT has a rock-bottom 0.03% expense ratio, perfect for long-term investors. SPY's expense ratio is 0.09%, but other S&P 500 Index ETFs have lower fees, including SPLG, IVV, and VOO. Similarly, total market funds like the Vanguard Total Stock Market Index Fund ETF Shares (VTI), the Schwab U.S. Broad Market ETF (SCHB), and the SPDR® Portfolio S&P 1500 Composite Stock Market ETF (SPTM) are also cheap. Seeking Alpha Plenty of low-cost options are available, so your choice comes down to strategy. ITOT, VTI, and SCHB are nearly identical, differentiated mainly by their number of holdings, which slightly changes the allocation between small-cap, mid-cap, and large-cap stocks. SPTM is more focused with 1,500 holdings, while SPY is the most focused with only 500. ETFs like ITOT are attractive because they are a single-fund solution, but in my experience, market-cap-weighted small- and mid-cap funds aren't optimal. Shareholders sacrifice quality for simplicity, and if you're willing to manage a few ETFs, I think changing strategies will pay off. Performance Snapshot vs. Peers The following table highlights selected periodic total returns through June 2024 for 30 of the largest large-cap blend ETFs by assets under management. The iShares S&P 100 ETF (OEF) was the top performer in this sample, reflecting the last decade's dominance by mega-cap stocks. Next are S&P 500 Index ETFs like SPY, followed by total market funds like ITOT. Finally, non-market-cap-weighted funds like the Invesco S&P 500® Equal Weight ETF (RSP) and the Invesco S&P 500® Low Volatility ETF (SPLV) did the worst. The Sunday Investor Market-Cap-Weighting Scheme: Large vs. Small-Caps Investors are always on the lookout for funds that can outperform the S&P 500 Index. However, that's a challenging task because it's very well balanced on most factors. I've ranked 253 large-cap blend ETFs based on fundamentals, and as shown below, SPY scores average or better on 6/7 factors.  Diversification: #68/253. Risk: #121/253. Growth: #95/253. Value: #171/253. Quality: #63/253. Momentum: #71/253. Sentiment: #77/253.  You can imagine the complex task managers face in trying to build a better mousetrap. I've only found a few factor-based funds that are as balanced as SPY, including FELC, FLQL, and SGLC. These ETFs have solid, albeit limited, track records, but my takeaway for readers is that there's nothing wrong with market-cap-weighted strategies for large-cap stocks. The weighting scheme promotes quality, and with value as the only glaring weakness, it's easy to find suitable complements in other categories to balance things out. Unfortunately, the same logic does not apply to small-cap stocks. To illustrate, the SPDR® Portfolio S&P 600™ Small Cap ETF (SPSM) only ranks average or better on 3/7 factors (diversification, value, momentum). The Schwab U.S. Small-Cap ETF (SCHA) has 4/7 factors above average, but the best-balanced ones are factor ETFs like the iShares U.S. Small-Cap Equity Factor ETF (SMLF) and the Principal U.S. Small-Cap ETF (PSC). These ETFs have higher expense ratios, but their results since October 2016 are impressive. Portfolio Visualizer The takeaway is that for the small-cap segment, market-cap-weighting schemes are not optimal, and by extension, so are market-cap-weighted total market funds like ITOT. ITOT Analysis Composition: Top 25 Holdings The following table highlights ITOT's allocation to its top 25 holdings, totaling 43.92% of the portfolio. VTI and SCHB have virtually the same allocations to these holdings, but remarkably, SPY's allocation is only about 4% more at 48.06%. SPTM is an \"in-between\" choice at 46.26%. The Sunday Investor These figures indicate total market investors aren't getting the diversification benefits they might expect. ITOT and SPY have 86.25% overlap by weight, meaning that small- and mid-caps only account for 13.75% of the fund. You can use these allocations as a guideline if you'd like to create a portfolio of two or three ETFs to compete with ITOT. Sector Exposures There is also little difference between the five funds from a sector allocation perspective. As shown below, ITOT's main difference with SPY is 1% more exposure to Industrials and 2% less to Technology. The Sunday Investor Fundamentals By Sub-Industry Finally, please consider the following table highlighting selected fundamental metrics for ITOT's top 25 sub-industries, which total 67.15% of the portfolio. Again, this concentration level is similar to VTI and SCHB and not much different from SPY. The Sunday Investor Here are three additional observations: 1. Since total market funds include some small- and mid-cap stocks, volatility is usually higher. ITOT has a 1.10 weighted average five-year beta compared to 1.07 for SPY, and since February 2004, ITOT's annualized standard deviation has also been slightly higher (15.19% vs. 14.81%). Portfolio Visualizer 2. One reason to buy ITOT over SPY is its better valuation, indicating small- and mid-cap stocks are potentially undervalued. ITOT trades at a weighted average of 29.12x forward earnings compared to 26.60x for SPY, or 22.14x and 22.99, using the harmonic weighted average method favored by sites like Morningstar. The caveat is that about 2% more of the fund are considered outliers, which are those with negative earnings or have P/E's above 60x. These stocks are either excluded from the calculation or capped at 60x, and when taking them into account, ITOT's valuation advantage is negligible. 3. ITOT and SPY are similar in many respects, but the most significant difference is in quality. In the table, I've highlighted each ETF's weighted average return on assets, return on equity, and return on total capital, along with a sector-adjusted profit score derived from Seeking Alpha Factor Grades. With a 9.03/10 profit score, ITOT is about average for the large-cap blend category but well behind SPY's 9.36/10 score. Investment Recommendation The 13.75% ITOT allocates to small- and mid-cap stocks do little to improve the portfolio's value metrics. Instead, it decreases quality and makes the portfolio riskier, so there isn't a good practical reason to choose ITOT over SPY. Instead, I suggest total market investors own three separate ETFs covering the small, mid, and large-cap segments and weigh them accordingly. SPY is a high-quality, large-cap fund that works great as a core holding. For the remaining two segments, the following factor ETFs are worth considering:  iShares U.S. Small-Cap Equity Factor ETF (SMLF). Principal U.S. Small-Cap ETF (PSC). Themes US Small Cap Cash Flow Champions ETF (SMCF). Victoryshares Small Cap Free Cash Flow ETF (SFLO). Distillate Small/Mid Cash Flow ETF (DSMC). Franklin U.S. Mid Cap Multifactor Index ETF (FLQM).   All these ETFs will boost your portfolio's profit score when used to complement SPY, and although they have higher expense ratios, it's a small price to pay to keep quality high. Regardless of your choice, I hope you'll agree that ITOT's market-cap-weighting scheme is not optimal and understand why I've only assigned it a neutral \"hold\" rating. Thank you for reading, and I look forward to your comments below.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.2","shortVersion":"4.29.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2450203530"}