ETF Comparison: iShares Russell 2000 ETF (IWM) Versus iShares Core S&P Small-Cap ETF (IJR)

IJR vs IWM: Total cost of ownership

When it comes to the total cost of ownership, both ETFs — iShares Russell 2000 ETF

However, IJR, part of iShares' "core" lineup, emerges as the more cost-effective choice with an expense ratio of just 0.06%, compared to IWM's 0.19%. This makes IJR significantly cheaper, costing just $6 annually on a $10,000 investment versus $19 for IWM.

But what about implicit costs, such as the bid-ask spread? Here, IWM has the edge with a 30-day median bid-ask spread of just 0.006%, indicating very high liquidity. IJR, while not as liquid, still performs well with a bid-ask spread of 0.013%.

Although this is double that of IWM, the difference is relatively minimal in practical terms—both essentially round to about 0.01%, which is considered very low.

Taking both explicit and implicit costs into account, IJR still holds the advantage as the more economical option between the two, especially when considering long-term investments where even small percentage differences in fees can add up.

IWM vs IJR: Methodology and holdings

Both ETFs embody competing index methodologies from two rival firms: S&P Global and FTSE Russell. As their names suggest, IWM tracks the Russell 2000 Index, while IJR follows the S&P SmallCap 600 Index. While both might seem similar in their yield, the devil is in the details.

The Russell 2000 Index, tracked by IWM, is broader, containing about three times as many holdings as the S&P SmallCap 600. It includes the 1001st to the 3000th largest U.S. equity stocks, requiring sufficient average daily trading volume and at least a 5% public float. This index is reconstituted annually, with adjustments made for IPOs throughout the year.

On the other hand, the S&P SmallCap 600, the basis for IJR, employs more stringent criteria. It requires annual turnover of 100% of shares outstanding, a minimum of 250,000 traded shares prior to committee evaluation, and at least a 10% public float.

Notably, it also includes a profitability screen—requiring the sum of the last four consecutive quarters' earnings to be positive, plus the most recent quarter. Unlike the Russell 2000, the S&P SmallCap 600's reconstitution is not scheduled annually but occurs as needed, based on committee decisions.

The exposure provided by each ETF also varies significantly: IWM is more heavily weighted towards technology and healthcare sectors, while IJR leans more towards financials and consumer discretionary. Both, however, allocate significantly to industrials.

Neither ETF is particularly top-heavy in terms of portfolio composition. Notable top names across these ETFs include companies like MicroStrategy, Super Micro Computer, Carvana, and Abercrombie.

IWM vs IJR: Risk and return

When it comes to historical performance, IJR beats IWM across the board. While the adage "past performance does not predict future results" usually holds true, there are strong reasons to consider an exception in this case.

First, examining the recent data doesn't offer conclusive insights. Over the last year and even on a year-to-date basis, performance comparisons are mixed. However, it's noteworthy that over the past three years, IJR has seen more inflows, indicating growing investor confidence. Conversely, during the same period, there has been a net exodus from IWM, with investors increasingly gravitating towards IJR.

Risk metrics for both ETFs reflect the inherent volatility associated with small-cap investments—both feature high standard deviations and have experienced deep, extended drawdowns. However, IJR shows a slightly better profile, likely due to its index methodology.

Looking further back, when backtesting both ETFs starting from 2000, IJR consistently outperforms IWM across several key metrics: it has a higher CAGR, lower volatility, and a better risk-adjusted return (Sharpe ratio). Why is this the case?

The answer lies primarily in the index criteria:

1. Russell 2000 Reconstitution: The annual reconstitution of the Russell 2000 is relatively transparent and predictable, which allows market participants to front-run changes by bidding up stocks about to enter the index, often making them expensive by the time they're included. In contrast, the S&P SmallCap 600's committee-led reconstitution process is more ad hoc and less predictable, which can mitigate such market manipulation.
2. Profitability Screen: The lack of a profitability screen in the Russell 2000 allows a broader array of companies, including those not yet profitable, to be included. The S&P SmallCap 600's requirement for a record of recent positive earnings acts as a quality filter that helps exclude financially weaker companies, which is particularly beneficial in the small-cap space.

In conclusion, for long-term buy-and-hold investors, I believe IJR stands out as the superior option due to its more rigorous index criteria and lower fees. However, for those looking to actively trade or utilize options, IWM still holds a place as a gold standard in the small-cap domain, thanks to its liquidity and comprehensive options chain.

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.