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Small Cap Value (IWN) - Thesis

iShares Russell 2000 Value ETF (IWN)
Expected Return: 9.0% per year
Expected Volatility: 22.0% per year
Rating: BUY

Thesis:
As long-term investors, we believe the equity markets will increase over time, and the small cap value portion of the equity markets will increase more than other styles (e.g. large cap growth), albeit with more volatility.  The iShares Russell 2000 Value ETF (IWN) offers reliable exposure to the returns of the small cap value portion of the U.S. equity market while avoiding the many pitfalls that are common among other ETFs and among other equity investments in general.

Holdings:
IWN generally invests at least 90% of its assets in securities of the Russell 2000 Small Cap Value Index.  The fund may invest the remainder of its assets in certain derivatives such as futures, options, swap contracts and cash equivalents.  The index is one of the most commonly followed equity indices in the U.S., and is largely considered the standard benchmark for small cap value stocks.  The performance of IWN has historically matched the performance of the Russell 2000 Small Cap Value Index very closely, and it should continue to track closely in the future because of its construction methodology.  Investors cannot purchase the actual index (the Russell 2000 Small Cap Value Index), and IWN is the next best thing.

Volume and Liquidity:
As the standard small cap value ETF in the US, IWN has significant volume and liquidity (total IWN assets exceed $5.5 billion).  Because of the volume and liquidity, the bid-ask spread is small (the bid-ask spread is the difference in price at any given time for someone buying the security and someone selling it.  There is a difference because the middle man takes a very small cut).  A small bid-ask spread is good because it saves you money when you trade.  Second, IWN trades very close to its net asset value (NAV) because of the large volume and liquidity.  NAV is the actual value if you add up the value of all the securities held within IWN.  For many less liquid ETFs, the NAV may vary from its actual market price (the price the ETF trades at in the market).  This makes IWN much less risky for investors compared to other ETFs that may vary widely in price versus NAV.  Additionally, small investors don’t have to worry about some big investor coming in, buying or selling an enormous amount of IWN, and subsequently adversely moving the market price away from its NAV because the volume of IWN is already so great that this risk is essentially non-existent.  Additionally, the fund manager, iShares has the ability to take open-market actions to virtually eliminate the potential price impacts of large trades.

Low Fees:
The net expense ratio on IWN is currently 25 basis points (0.25%).  This is extremely low for small cap value market exposure; it is good for investors because it allows them to achieve better returns on their investment.  For comparison, small cap mutual funds (a common competitor to ETFs) may charge over 200 basis points (2.0%) per year, and they tend to deliver worse performance over the long-term.  Additionally, there is no expensive sales charge or separate investment advisor fee because IWN can be purchased directly through a discount broker (e.g. Scottrade, E*TRADE, TD Ameritrade, Interactive Brokers, etc.).  The discount broker may charge you a one-time trading fee of $8 or less, but this is much better than the 2-5% sales charge/management fee you’d get charged by a full service financial advisor.  Additionally, there is no hidden 25 basis point (0.025%) annual 12b-1 fee paid to someone for “servicing your account.”  The bottom line here is that IWN is a very low cost way to get great exposure to the equity market and to build considerable wealth over the long-term.

Dividend Reinvestment:
One last point of consideration, IWN pays a quarterly dividend (around 2.16% per year), and this dividend is NOT automatically reinvested back into IWN (this is standard protocol for ETFs and stocks).  This mean you’ll build up a cash balance in your account if you don’t withdraw it or manually reinvest it.  As a long-term investor, cash is generally a drag on investment performance.  Unless you plan to withdraw and use the cash, we highly recommend you develop a process to reinvest it.  Most discount brokers (Scottrade, Interactive Brokers, etc.) offer automatic dividend reinvestment programs.  We highly recommend you sign up for these programs to avoid the situation where cash builds up in your account and becomes a drag on your long-term investment performance.  Reinvesting dividends is important.

Conclusion:
IWN is a very low cost, relatively low risk, security that allows investors to build significant wealth over the long-term.  We consider IWN to be a basic building block for long-term wealth, and we rate IWN as a “Buy.”  For more information, you can view the IWN fact sheet here.

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