SCHG: The Best Performing Growth ETF As Long As Sentiment Remains Positive

Seeking Alpha has just opened a Growth and Total Return chat which is a welcome addition for those of us who invest for capital growth rather than an income stream. And the discussion there has turned my thoughts to the topic of which Growth-oriented ETFs are the most attractive.

There are several ways to approach this topic. Some people invest in Mega Cap ETFs like (XLG) or The Vanguard Mega Cap ETF (MGK) since these have been dominated for years by the huge companies that have grown their earnings aggressively over the past decade. Others invest in the Invesco QQQ Trust (QQQ) whose heavy investment in Tech stocks and low dividend payout has made it very much a growth oriented ETF for decades.

But the most obvious way that many investors take to tilt their portfolios towards Growth is to invest in ETFs that have the word “Growth” in their titles. In this article we’ll look at the most popular of these Growth ETFs and see which one is the most appealing, based on historical performance and index methodology.

VUG Is The Top Dog Among Growth Indexes

The most popular Growth ETF by a long shot is the Vanguard Growth Index ETF (VUG). This ETF is a share class of The Vanguard Growth Fund. The ETF share class currently has an AUM of $116.2 Billion while the entire Vanguard Growth Fund has an AUM of $220.0 Billion. VUG has a low expense ratio of .04%.

VUG holds 200 stocks chosen by index provider CRSP out of a “universe” of large cap stocks. The stocks that don’t make it into this index are found in the Vanguard Value Index ETF (VTV). Years ago I wrote about VUG I discovered that this market cap weighted ETF it was full of companies like McDonald’s (MCD) which had experienced unimpressive earnings growth over the previous few years.

When I investigated the Vanguard Value Index ETF (VTV) I learned the methodology the CRSP indexes use to populate its growth and value indexes divides all its total market holdings into Growth or Value stocks based on the metrics of price to book and forecasted earnings growth. If a stock doesn’t really have characteristics of either, the index creators allocate a portion of that stocks its market cap to each style. That explained why so many of VUG’s “Growth” stocks were growing earnings slowly. You can read the details of VUG’s index construction rules HERE.

Right now VUG holds 200 stocks and VTV holds 342 stocks. So VUG holds 37% of all stocks in its index creator’s large cap “universe.” They include REITs and companies that are not profitable.

I don’t know about you, but when I invest in an Growth ETF I want it to be filled with companies whose earnings are expected to grow at a rate far higher than the median.

That made me wonder about whether competing ETFs from other fund companies would be a more satisfying choice for those of us who seek ETFs that are more likely to provide above average long-term capital appreciation.

The Best Performing Popular Growth ETFs Over The Past Decade

I limited my search to the most popular Growth ETFs ranked by AUM as they are the most likely to survive in the highly competitive ETF market. Avoiding the closure of an ETF is a major consideration for those of us investing for share price growth in Taxable accounts as closure of a long-term holding could leave us with significant taxable capital gains.

I also only looked at Price performance, instead of following my usual practice of evaluating Total Return. That’s because Growth stocks typically pay no or low dividends. Their value to investors is in their increasing share prices. This is also beneficial for those of us investing in taxable accounts as low dividends mean little taxable income.

Below you can see how the largest ETFs that have the term “Growth” in their titles performed over the past decade.

The 10 Year Performance of the Largest US “Growth” ETFs

All Growth ETFs Significantly Outperformed The Vanguard S&P 500 ETF But Two Excelled

Over the past decade, all six of these Growth ETFs performed far better than an investment in an S&P 500 ETF like the SPDR S&P 500 ETF Trust (SPY) or The Vanguard S&P 500 ETF (VOO) would have over the same period.

For reference SPY’s price grew by 179.02% and VOO’s price grew by 177.33% over the past 10 years, far less than that of the weakest of the 6 Growth ETFs whose growth you see listed above.

VUG’s performance over the past decade has been slightly better than middling, compared to its competitors. It performed at least 20% better than the iShares S&P 500 Growth ETF (IVW), the SPDR Portfolio S&P 500 Growth ETF (SPYG), and the iShares Core S&P US Growth ETF (IUSG).

But as you can see, two ETFs significantly outperformed VUG: The Schwab U.S. Large-Cap Growth ETF (NYSEARCA:SCHG) and the iShares Russell 1000 Growth ETF (IWF).

This Outperformance Persisted In All Time Frames Throughout The Past 10 Years But Not During The Long Stagnant Market Of The 2000s

As you can see below, SCHG and IWF continued to outperform when we shortened the time frame.

5 Year Price Performance of the Largest US Growth ETFs

1 Year Price Performance of the Largest US Growth ETFs

How Did These ETFs Perform During Prolonged Recessions?

Because the period since 2013 has been one where Growth-oriented stocks have been by far the strongest performers I thought it important to see how these Growth ETFs performed during the long years during which Growth did not outperform the market.

Growth ETF Price Performance Since Sept 2000

During the period that begins in 2000, which is when the long stagnant period of flat stock price growth began, SPY’s price return was dramatically better than that of any of the Growth ETFs that were trading at the time except for The Vanguard Growth Index Fund Investors Shares (VIGRX). VIGRX was the mutual fund version of the fund family that only later added the ETF share class of the same fund which we know as VUG. SCHG only began trading on December 11, 2009 almost a decade after the other ETFs charted above.

That means that not only do we not know how top performer SCHG would perform in a prolonged recessionary and/or stagnant environment, but we also don’t know how it would have performed during the Great Financial Crisis of 2008.

What we do know is that back when growth stocks were performing poorly, IVW, which holds a selection of growth stocks chosen from the actively selected S&P 500 index, significantly outperformed IWF during this long, dark period in U.S. market history. As IWF is the ETF whose return was most similar to SCHG during the past decade, this difference in performance when market sentiment turns against growth would make me question how SCHG would hold up under adverse market circumstances.

Index Methodologies Hold Some Clues As To Why And How Performance May Vary

Let’s look at how the indexes tracked by SCHG, IWF, and IVW are constructed as it is the difference in their index methodologies that might explain most of the difference in their performance.

Though we should also remember that over long time periods differences in their expense ratios over the past 24 years ago may also have contributed to their differing performances. Expense ratios for ETFs and funds were much higher back in 2000 than they are today and if just 1 or 2% the money earned by the stocks in an ETF that were deducted from the ETF’s NAV for expenses that would compound significantly over 24 years. But unfortunately, we have no way of retrieving the actual expense ratios for these ETFs and the Vanguard fund starting back in 2000.

One other caveat: ETFs and funds may have changed indexes over this long period or the indexes may have modified their methodologies. Vanguard’s funds did not track CRSP indexes back in 2000 as they do now. It would be a major research project to determine how the indexes tracked by these other ETFs have altered over the years. This should make us cautious in using backtests based on this decades-old performance data to predict future ETF performance except based on very obvious differences.

SCHG Tracks The Dow Jones U.S. Large-Cap Growth Total Stock Market Index

SCHG contains a subset of all the stocks that the Dow Jones Total Market index methodology classifies as “Large Cap.” There are currently 750 Large Cap stocks in that index. Of these, only one third, 250 stocks, are held by SCHG. This suggests that SCHG’s methodology may be more precise than the CRSP methodology used by VUG in determining what stocks are Growth and which are value as a lower percent of the total index’s stocks make it through their Growth screen.

SCHG has a very low expense ratio of .04%

Its index’s methodology is described HERE. The methodology is complex, but involves ranking all stocks in the Dow Jones Total Stock Market’s stocks by 6 factors,

• 1. Projected Price-to-Earnings Ratio (P/E)
• 2. Projected Earnings Growth: Based on expected three-to-five year annual increase in operating EPS.
• 3. Price-to-Book Ratio (P/B)
• 4. Dividend Yield: Based forward yield.
• 5. Trailing Revenue Growth: Based on annualized revenue growth for the previous five years.
• 6. Trailing Earnings Growth: Based on annualized EPS growth for the previous 21 quarters.

Stocks are ranked in each of the 6 categories and then complicated statistical methods are used to divided them up into Growth and Value. The resulting index is market cap weighted.

SCHG uses more valuation criteria and possibly more sophisticated valuation criteria than the other ETF indexes we will be examining to choose its stocks. This might partially explain its out performance during the period when Growth dominated market returns. But the smaller number of stocks it holds is also a factor. Giving it more concentration in the strongest growth stocks as it is market cap weighted.

IWF Tracks The Russell 1000 Growth Index

It holds 440 stocks, chosen out of a universe of 1000. That tells us right away that it isn’t as selective as to what constitutes Growth as is SCHG or, as we will see below, fellow Blackrock fund, IVW.

Its .19% expense ratio is slightly higher than that of SCHG.

It uses two metrics to determine which of the stocks in the larger Russell 1000 index are growth stocks. The Russell 1000 is a Large Cap index. Its methodology is described in detail HERE.

The Growth characteristics of the stocks in its “universe” are determined based on what index provider FTSE calls a “‘non-linear probability’ method.” It tells us

The degree of certainty that a stock is value or growth, based on its relative book-to-price (B/P) ratio, I/B/E/S forecast medium-term growth (two year) and sales per share historical growth (five year). This method allows stocks to be represented as having both growth and value characteristics, while preserving the additive nature of the indexes.

So like VUG it contains a significant number of stocks that are probably not what you think of when you think of a growth stock, because there are significant holdings of companies whose growth score might have been only 20% and their value score 80%, but shares making up 20% of the stock’s total market cap are still put into the Growth index.

Nevertheless, IWF has had a much better performance during the period since 2013 when growth stocks have yielded the most gains than has VUG and a much worse performance during the period when growth stagnated starting in 2000. So something in its “non-linear probability” method seems to help it load up with growthier stocks.

IVW Tracks The S&P 500 Growth Index

IVW, which outperformed only during the long flat decade of the 2000s but lagged during the recent decade holds 228 stocks chosen out of the S&P 500 index, like VUG it ranks all the stocks in its “universe”, i.e. the S&P 500 by how Growthy and how Valuey they are and then splits all these stocks into two groups. Stocks that fall in the middle are split up between the two styles.

Its expense ratio, .18% is slightly higher than that of SCHG.

It uses three criteria to determine how growthy a stock might be:

• Sales growth
• The ratio of earnings change to price
• momentum

As it currently holds almost half of the stocks in the S&P 500, market cap weighted, it is understandable that it did much better than true growth ETFs during the long period when the market was stagnant and the S&P 500 eked out a tiny 2% gain. It is closer to the S&P 500 than to a true growth index. And like the S&P 500 it must exclude all stocks that don’t have a history of profitability, no matter how strongly their sales are growing or what their future earnings are projected to be.

Top Holdings Of All Three ETFs Are Currently Almost Identical

Below you can see the top 10 holdings of all three of these ETFs as currently reported by Seeking Alpha.

Note that Seeking Alpha reports a slightly different number of stocks held in each ETF than do the ETF providers. I have used the provider’s numbers in the text above.

As you can see, they are almost identical, despite the differing number of holdings. All of these ETFs currently hold between 54 and 59% of their value in the same top 10 stocks which are also the top stocks in the S&P 500 and just about every other Market Cap Weighted Large Cap or Total Market ETF. Their outperformance can easily be explained simply by the fact that they hold a larger percentage of these top 10 stocks than does the S&P 500 or the U.S. total stock market as a whole.

Your Feelings About Market Sentiment In The Future Decade Should Determine Your Choice Of Growth ETF

My suspicion is that SCHG and IWF are outperforming now because they include a somewhat curated collection of unprofitable stocks that are expected to grow earnings dramatically in the future while IVW and SPYG hold only stocks chosen from the S&P 500 which demands a history of several quarters of profitability before a stock is included. The smaller the number of holdings, the more concentrated in true growth stocks these ETFs may be, too. And the more sophisticated the algorithm used to select stocks, the more the ETF may be a “true” growth ETF. This would explain SCHG’s consistent outperformance during the past decade.

So it is safe to conclude that in times when market sentiment is bullish, driving stocks upwards, you are likely to do best investing in SCHG. However, if sentiment turns negative, due perhaps to a stagnating economy where company earnings growth stalls across the board, the very factors that made SCHG a great buy during the years of upward market momentum may hurt you.

The very different performance of Growth ETFs during the stagnant years that began in 2000 suggest that you are likely to be hurt more if you are investing in an index like SCHG or IWF which hold more speculative, unprofitable stocks. So much of what constitutes “growth” in the methodologies of these indexes includes projected forward earnings.

When earnings decline during a prolonged recession, or after sentiment crashes as it did in 2000, the mildly active stock selection criteria and profitability requirement used to build the S&P 500 index’ might make IVW a better choice. But not all S&P 500 based growth ETFs are equal. SPYG’s terrible performance in the period after 2000 and lagging performance now would make me avoid it.