ishares Russell Microcap or Bridgeway Ultra-Small Co. ?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
david99
Posts: 719
Joined: Sat Mar 03, 2007 10:56 am

ishares Russell Microcap or Bridgeway Ultra-Small Co. ?

Post by david99 »

I want to invest in the micro cap asset class and I was wondering if it would be better to invest in the ishares Russell Microcap Index Fund (IWC) or the Bridgeway Ultra-Small Co. Market Fund (BRSIX )?

Thanks for your advice.

David
Last edited by david99 on Sun Mar 11, 2007 10:07 am, edited 2 times in total.
livesoft
Posts: 86079
Joined: Thu Mar 01, 2007 7:00 pm

Post by livesoft »

Both BRUSX and BRMCX are closed to new investors, aren't they?
So there's your answer.

There are other microcap ETFs, such as PZI, but the daily trading volume is miniscule, thus beware of the bid/ask spread. Even on a high volume day such as 2/27 you may not be able to unload at a price you like.
microlepis
Posts: 80
Joined: Wed Feb 21, 2007 6:45 am
Location: Forum Purgatory

Post by microlepis »

livesoft wrote:Both BRUSX and BRMCX are closed to new investors, aren't they?
So there's your answer.
David is probably referring to BRSIX, the passively managed fund. That is open to new investors the last time I checked.

I'm not that familiar with the ETFs David, and livesoft is certainly right that there are bid ask spread concerns, but my initial reaction would be to make the decision based upon whether an ETF or open-end mutual fund would be more convenient based upon how you invest. If you would be making a lot of small investments, then I would definitely go with BRSIX.

By the way, if valuations make a difference to how you invest, I would be cautious about investing in this asset class now. In fact, I sold my position in BRSIX last year because I view microcap valuations as excessive.

Hope this helps,
Dr. Jim
"It is better to reign in Hell [or forum purgatory] than serve in heaven" -- Milton
User avatar
Murray Boyd
Posts: 794
Joined: Mon Feb 19, 2007 5:00 pm

Post by Murray Boyd »

IWC is an actual index fund. BRSIX will probably drift up out of microcaps because of tax-management. Last time I checked IWC was invested in twice as many companies, which I think is pretty important. If there is outperformance from microcaps it's going to come from a couple of lucky winners. Best to own as many as possible.

What's the problem with microcap valuations?
yobria
Posts: 5978
Joined: Mon Feb 19, 2007 10:58 pm
Location: SF CA USA

Post by yobria »

Personally I just go with RZV, which has a market cap just a little higher ($550M vs $350M for IWC), but is cheaper, and is free of small growth.

But btw IWC and BRSIX I'd go with IWC. Active funds may suffer from tracking error, as BRSIX has done lately.

Nick
microlepis
Posts: 80
Joined: Wed Feb 21, 2007 6:45 am
Location: Forum Purgatory

Post by microlepis »

Murray Boyd wrote:IWC is an actual index fund. BRSIX will probably drift up out of microcaps because of tax-management. Last time I checked IWC was invested in twice as many companies, which I think is pretty important. If there is outperformance from microcaps it's going to come from a couple of lucky winners. Best to own as many as possible.
Those considerations are food for thought, but I'm not aware of any evidence that they are more than simply speculation. According to M*, the current average market capitalization of BRSIX's holdings is 304 million and IWC is 358 million. Moreover, the current capitalization limit for BRSIX, which attempts to follow the CRSP 10 decile, is 331 million; the capitalization limit for IWC, which follows the Russell microcap index, is 550 million. Thus, IWC ought to hold more stocks simply because it is required to invest in the stocks of larger companies-- which also has the undesirable effect of decreasing the extent to which you're exposed to the size premium. As for tax management, most of the data I have seen suggests that it tends to enhance the returns of small-cap funds because it helps capture the momentum effect documented in small caps.
What's the problem with microcap valuations?
They are high.
yobria wrote: But btw IWC and BRSIX I'd go with IWC. Active funds may suffer from tracking error, as BRSIX has done lately.
Not sure why you're describing BRSIX as an active fund. Its stated goal is to match the returns of its underlying index. All index funds suffer from tracking error. It is true that BRSIX has pretty significant tracking error (and so the SEC won't let it call itself an index fund), but that is an unintended result of tax management and the difficulties of running an open-end mutual fund investing in the smallest companies out there. It is not a result of any other type of active management as far as I know. And the tracking error has gone both ways with his fund; it has both outperformed and underperformed its index, so over the long run I don't believe the tracking error is going to hurt returns.

Regards,
Dr. Jim
"It is better to reign in Hell [or forum purgatory] than serve in heaven" -- Milton
Topic Author
david99
Posts: 719
Joined: Sat Mar 03, 2007 10:56 am

Post by david99 »

Thank you very much for all your advice. I'm only going to invest 2 or 3% of my portfolio in micro caps as Rick Ferri recommended in All About Asset Allocation and your input is very helpful.

Thanks

David
yobria
Posts: 5978
Joined: Mon Feb 19, 2007 10:58 pm
Location: SF CA USA

Post by yobria »

Not sure why you're describing BRSIX as an active fund. Its stated goal is to match the returns of its underlying index. All index funds suffer from tracking error. It is true that BRSIX has pretty significant tracking error (and so the SEC won't let it call itself an index fund), but that is an unintended result of tax management and the difficulties of running an open-end mutual fund investing in the smallest companies out there.
Ok, call it a quasi-index fund with tax, tracking, and operational issues. Still no reason to own it with IWC available.

Nick
microlepis
Posts: 80
Joined: Wed Feb 21, 2007 6:45 am
Location: Forum Purgatory

Post by microlepis »

yobria wrote: Ok, call it a quasi-index fund with tax, tracking, and operational issues. Still no reason to own it with IWC available.
Rather an exaggeration. Reasons to own BRSIX:

1. No need to worry about bid/ask spreads on thinly traded ETFs.
2. Don't have to pay brokerage commissions or worry about reinvestment of dividends for ETFs.
3. More significant size premium because of smaller average market cap.
4. Possibly greater tax efficiency through tax management. (We don't have a significant history for microcap ETFs yet to know how tax efficient they are).
5. Possibly greater returns through increased size premium and capturing momentum effect via tax management.

I'm not saying IWC is a bad choice; just saying it's not the only reasonable choice. I think it depends upon your situation.

Regards,
Dr. J.
"It is better to reign in Hell [or forum purgatory] than serve in heaven" -- Milton
SmallHi
Posts: 1718
Joined: Wed Feb 21, 2007 5:11 pm

Post by SmallHi »

Dr. J is right here, despite the cost differences, BRSIX is a better microcap holding than IWC.

If for nothing else, it is only a matter of time before index reconsitution arbitrageurs take ahold of the annual "refreshing" of this index's constituents, as has been documented with all other widely followed indexes that have a transparent reconstitution schedule (Russell 2000, MSCI EAFE for example).

Illiquid micro cap stocks are one area where you want to follow a silent index (say CRSP 9-10, 10, or bottom 4% of market) to avoid these issues, and give yourself the option to not have to slavishly track an index for tracking error purposes, and also pursue block trading opportunities and securities lending activities where possible.

smallHI
User avatar
stratton
Posts: 11085
Joined: Sun Mar 04, 2007 4:05 pm
Location: Puget Sound

Post by stratton »

Rick Ferri uses First Trust DJ Select Microcap (FDM) for Microcaps in All About Index Funds 2nd Ed. ER is 0.50. The only problem I see with this ETF is it only has ~$30 million invested in it and I suppose its conceivable that it might be sold off and the money returned to investors if it doesn't get big enough.

Paul
yobria
Posts: 5978
Joined: Mon Feb 19, 2007 10:58 pm
Location: SF CA USA

Post by yobria »

Dr. J is right here, despite the cost differences, BRSIX is a better microcap holding than IWC.
No one's right or wrong here- we all just have opinions. BRSIX has less value, is underperforming, isn't a true index fund, has higher expenses, has far higher unrealized cap gains and a less tax friendly structure. The only reason it's even discussed is before ETFs there was no other choice.
If for nothing else, it is only a matter of time before index reconsitution arbitrageurs take ahold of the annual "refreshing" of this index's constituents, as has been documented with all other widely followed indexes that have a transparent reconstitution schedule (Russell 2000, MSCI EAFE for example).
That's a non-issue IMO. So little of the microcap world is indexed. Stocks being added to the R2K are already in this index, so you get the bounce when these are added. Plus Barclay's has the best arb guys in the business, and has the right to take steps to maximize returns during the reconstituion (like buying stocks likely to be added to the index before they're announced by Russell).

Nick
VennData
Posts: 580
Joined: Mon Feb 26, 2007 4:52 pm

Post by VennData »

The only thing that gave me pause was the 65 Basis point expense ratio. I know they are not a "pure" index fund but that seems a bit high.

Having said that I have a small allocation to BRSIX, so it didn't stop me from sending in the check.

My wish is that Dimensional Fund Advisors would allow DIYers to get into their funds. Maybe they don't know wny way to have people moving money in and out without advisors, but penalty fees would be w place to start.

I've sent them a few emails over the years, they say get a broker. From the outside looking in, it seems like an odd policy.
SmallHi
Posts: 1718
Joined: Wed Feb 21, 2007 5:11 pm

Post by SmallHi »

I disagree with Yobria.

No one buys a micro cap index to get value exposure. You do it to get small cap exposure. They both track micro cap indexes, and any current differences in value orientation are likely random, so don't base your decision on that observation.

Index reconstitution has nothing to do with index buys. Index funds (and ETFs) are part of the problem of index reconstitution. Anyone with a spreadsheet can figure out a few weeks prior to Russell reconstitution what stocks will be leaving/entering the Russell Micro Cap index, and can buy/sell accordingly. This pushes the prices up/down right before index fund must buy. They are then sold upon being added to the index.

This means individuals, but mostly institutional investors such as hedge funds. Barclays takes no steps that I am aware of to mitigate this. They are an index fund by definition, and their main goal is to minimize tracking error, which means buying/selling the stocks on the day reconstitution demands.

This is a huge problem with the Russell 2000 index currently (and the fact that Russell 1000 buys the stocks that leave the Russell 2000 have not helped this issue at all), and will likely be most severe for the Micro Cap index in time.

If you run a regression on 3 popular microcap indexes (Dimensional Micro Cap Index, CRSP 9-10, and Russell MicroCap), you see that Russell is the most undesirable index by far. ..and this is before reconstitution issues set in.

Look no further than the Russell 2000 to see what can happen when that takes hold. Since 1979, the factor similar CRSP 6-10 or Dimensional Small Cap Index has outpaced the Russell 2000 Index by 1-1.5% annually. Most of this has to do with tracking silent indexes with no reconstitution arbitrage going on.

Stay away from this thing is my advice if you can get BRSIX!

smallHI
yobria
Posts: 5978
Joined: Mon Feb 19, 2007 10:58 pm
Location: SF CA USA

Post by yobria »

SmallHI-

You can theorize all you want about transactional problems Barclays may not be smart enough to solve. But BRSIX has plenty of problems which aren't theory, but reality. From their latest semi-annual report:
For the calendar year, the Fund was up 11.48%, lagging our primary market benchmark by 7.94%
Think I'll stick to index funds...

Nick
SmallHi
Posts: 1718
Joined: Wed Feb 21, 2007 5:11 pm

Post by SmallHi »

Let me rephrase my suggestion:

If you understand the random tracking error that can occur even in portfolios of several 000 micro cap stocks, and that not having to slavishly track an index will likely lead to higher returns due to greater flexiblity(especially if that index has a higher orientation to small cap stocks than others you are considering in the first place), then buy BRSIX.

If very short term outcomes and only trailing your index over any short period are what really matter to you(no matter how poor those index returns will turn out to be), then buy an index fund such as IWC.

Tracking error does affect funds that don't slavishly track their indexes. Yobria is right, the last few years have seen negative tracking error (random). The previous years saw the same degree of positive random tracking error. BRSIX outperformed its index by 13%, 13%, and 10% from 2000 to 2002.

Its up to you.

Incidentially, this is also an issue with overseas portfolios. The abstract of a 2001 paper by Elroy Dimson indicates this:

Capturing the Value Premium in the U.K. 1955-2001

ELROY DIMSON
London Business School - Institute of Finance and Accounting
STEFAN NAGEL
Stanford Graduate School of Business; National Bureau of Economic Research (NBER)
GARRETT QUIGLEY
Dimensional Fund Advisors
--------------------------------------------------------------------------------
January 2003




Abstract:
Using a new dataset of accounting information merged with share price data we find a strong value premium in the U.K. for the period 1955-2001. It exists among small-caps as well as among large-caps. However, there are challenges for small-cap managers wishing to capture these higher expected returns. We show that rebalancing-induced portfolio turnover for indexed small-value strategies can be substantial. Coupled with the relative illiquidity of the U.K. market for small-value stocks, this calls for strategies that sacrifice tracking accuracy in favor of reduced trading needs and lower trading costs.
User avatar
Murray Boyd
Posts: 794
Joined: Mon Feb 19, 2007 5:00 pm

Post by Murray Boyd »

That's what I always say: historical small premiums are based on a fantasy world of low transaction costs. Given the trading costs in the past maybe we should be talking about the small penalty.
BrianTH
Posts: 1340
Joined: Tue Feb 20, 2007 5:10 pm

Post by BrianTH »

Just my two cents, but personally I plan to avoid growthy microcaps, which means I would only be interested in a valuey microcap fund. Moreover, I figured out I could get the limited amount of microcaps I would want within relatively inexpensive small value funds. So, barring a very cheap microcap value index fund coming on the market, I currently see no need for a microcap-specific fund.
SmallHi
Posts: 1718
Joined: Wed Feb 21, 2007 5:11 pm

Post by SmallHi »

Murray,

You probably shouldn't say that, as the longest running passive Micro Cap fund we have -- the DFA Micro Cap Fund, has over 25 years worth of history indicating they can capture the size premium, and are able to run this portfolio with negative trading costs due to their strucutured (non index tracking)nature.

From 1982-2006:

CRSP 9-10 = +13.11%
DFSCX = +14.07%

Note BRSIX is run in a similar fashion to DFSCX, ie not indexed but structured, and should also benefit over time (but not guaranteed to do so).

smallHI
User avatar
Murray Boyd
Posts: 794
Joined: Mon Feb 19, 2007 5:00 pm

Post by Murray Boyd »

SmallHi wrote:Murray,

You probably shouldn't say that, as the longest running passive Micro Cap fund we have -- the DFA Micro Cap Fund, has over 25 years worth of history indicating they can capture the size premium, and are able to run this portfolio with negative trading costs due to their strucutured (non index tracking)nature.

From 1982-2006:

CRSP 9-10 = +13.11%
DFSCX = +14.07%

Note BRSIX is run in a similar fashion to DFSCX, ie not indexed but structured, and should also benefit over time (but not guaranteed to do so).

smallHI
You're right. I should have been more specific. It's those 1926-present or 1959-present stats that I can't accept.
User avatar
Russell F.
Posts: 51
Joined: Mon Feb 19, 2007 4:27 pm

Post by Russell F. »

yobria wrote:
Plus Barclay's has the best arb guys in the business, and has the right to take steps to maximize returns during the reconstituion (like buying stocks likely to be added to the index before they're announced by Russell).

Nick
Another instance, similar to what you described above, is when a company pending spin-off and is picked up for inclusion in an index (quick example, SLE spinning off HBI, which was picked up in the S&P 400).

In some cases, index fund managers buy shares on a "when-issued" basis. A "when-issued" market for the spin-off stock generally develops about 10 to 14 days to the actual spin-off date.




Best,

Russell F.
Post Reply