Compose your own small-cap value portfolio
People - Investing
Wednesday, 07 November 2007 10:59

There are several ETF's investing in companies in the small-cap value segment. Such companies have proven to be the best investments in the long run. Ticker symbols of  these funds are RZV, IJS, VBR, JKL, EES, IWN and DES.

The added value of investing in such ETFss is that their underlying indices select the right small-cap value companies for you and that your investment is spread over hundreds of companies. The disadvantage of investing in these funds is that their definitions of small-cap and value do not necessarily correspond to your definitions. Some of these funds also hold mid-caps, or companies that post a loss, or companies that have growth characteristics such as a high PE. Some of these ETFs can contain investment funds and REITs as well, which I don't like.

But if you have time and if your are prepared to take a little bit more risk then you might compose your own small-cap portfolio. Because you select the companies yourself you are sure that you hold the right companies in terms of value and size characteristics. By investing yourself you don't have to pay any management fees either. On the other hand your "fund" will contain fewer companies than a typical ETF does.

First determine how many companies your fund will contain. Choose a low number but choose at least ten companies in order to reduce your risk. The next step is selecting the companies.

Rather than browsing through long lists of companies you can rely on the work of others: on the holdings of the ETFs mentioned above. These funds should publish their holdings, and if not their holdings can be viewed in for instance the MorningStar or Yahoo website. Pick one or two companies of each ETF, for instance companies with a good PE. With this method you probably end up with the value stocks within the small-value indices. You might weight the companies by earnings but an equal weight fund will probably perform just as good.

Suppose I would select 10 funds from the holdings of IJS, RZV, VBR, JKL, EES, IWN and DES. For practical reasons I only choose from the ten biggest holdings of each fund, which are published by Yahoo. My emphasis is on backward and forward PE. So in that case my portfolio contains the following companies:

Pick from CompanyTickerTrailing PEForward PEMarket-capPrice Nov 7, 2007
 RZVSpherion Corp SFN
  8.4
 12.7 0.46B7.51
 IJS
Anixter International
 AXE 12.4 10.7
 2.6B
68.11
 VBRCommercial Metals
 CMC
 10.3   8.9 3.6B
68.11
 VBRReliance Steel & Aluminium
 RS
 10.9   9.6 4.3B55.28
 JKLPlatinum Underwriters
 PTP
 7.0
  7.4
 2.0B
34.28
 EESOwen Financial OCN
 7.4
 7.8
 0.40B
5.72
 EESBrookfield Homes
 BHS
 4.6
 ?
 0.45B
15.79
 DESDeluxe
 DLX
 12.6 12.0
 1.9B
34.75
 IWNAspen Insurance
 AHL
 5.5 6.5
 2.4B
26.12
 IWNOil States International
OIS
 8.8
 8.6
 1.8B
35.36

The companies in the portfolio are still small. But because I have selected the companies from the biggest holdings of the seven ETFs my portfolio is shifted somewhat to the midcap segment. On the other hand this portfolio is also shifted to the value side compared to the holdings of the underlying ETFs.

Of course you have to rebalance your portfolio every year. You could choose to sell the stocks that have got growth characteristics at the end of April. In that case you will have some cash during the volatile Summer period. You could rebalance your fund if the market suddenly falls. If this does not happen then you could rebalance at the end of October.