Second Wave of Russell ETFs Comes Ashore

Boom!  Russell Investments jumped from sponsoring just one ETF to 17 in a span of less than 10 days.  The firm introduced a 10-fund suite of Russell Factor ETFs last Friday (5/27/11).  The second wave of new products comes quick on the heels of the Russell Investment Discipline Index ETFs rollout.

The Russell Factor ETFs allow investors adjust exposure to various risk factors that exist within investment portfolios, thereby helping manage overall portfolio risk.  Russell Investments teamed up with Axioma, a leading provider of advanced risk analytics, to create the underlying Russell-Axioma Factor Indexes.  Russell Factor ETFs track these indexes and attempt to provide focused exposures to specific risk factors in both large cap and small cap equity portfolios.

Constructed from components of either the Russell 1000 Index or Russell 2000 Index, each ETF intends to deliver ongoing exposure to a specific risk factor while limiting portfolio turnover and exposure to other factors.  Unlike other ETFs that track the performance of a specific market segment, they are intended to provide a specific factor exposure.  Additional background information is provided in the Russell Factor ETFs Educational Overview.

The five ranking (risk) factors are high beta, low beta, high volatility, low volatility, and high momentum.  I've mentioned before that beta is one of the most misunderstood investment terms as many people equate it to volatility.  These new products clarify that beta and volatility are not the same thing.  Investors should understand the differences before making their fund selections.

Index Construction Methodology

Each of the new ETFs uses the same basic index construction methodology, which is briefly summarized as:

1. The stocks from each universe (Russell 1000 Index and Russell 2000 Index) are separately ranked by each of the five factors (high beta, low beta, high volatility, low volatility, and momentum), creating a total of ten rankings.
2. Starting with the highest ranked stock for a specified factor and universe, ten “target portfolios” are created by adding the next-highest ranked stock until the target portfolio has a total capitalization of 35% of the specified universe.
3. Each fund's underlying index then selects a portfolio of up to 200 stocks from the specified universe to optimally track the returns of the target portfolio while managing turnover and neutralizing exposure to the other factors.
4. Each underlying index is then reconstituted monthly to maintain its focus on the desired factor.

Overview of New ETFs

The five new large cap ETFs have expense ratios of 0.49% and their stock selection universe is the Russell 1000 (large cap) Index.  The five small cap ETFs have an expense ratio of 0.69% and will select stocks from the Russell 2000 (small cap) Index.  A brief description of each fund, underlying index ranking factors, and current number of holdings follows along with links for investors seeking additional details.  The prospectus (pdf) covers all ten funds.

Russell 1000 High Beta ETF (HBTA) – the underlying Russell-Axioma U.S. Large Cap High Beta Index attempts to track stocks from the Russell 1000 with high predicted beta, a measure of the sensitivity of a stock's price to changes in the base index.  The fund currently holds 96 stocks with the largest allocation to Union Pacific (UNP) at 2.1% (HBTA overview and top holdings).

Russell 1000 Low Beta ETF (LBTA) – the underlying Russell-Axioma U.S. Large Cap Low Beta Index attempts to track stocks from the Russell 1000 with low predicted beta, a measure of the sensitivity of a stock's price to changes in the base index.  The fund currently holds 119 stocks with the largest allocation to Reynolds American (RAI) at 2.0% (LBTA overview and top holdings).

Russell 1000 High Volatility ETF (HVOL) – the underlying Russell-Axioma U.S. Large Cap High Volatility Index attempts to track stocks from the Russell 1000 with high volatility based on their variability in total returns over the last 60 days.  The fund currently holds 113 stocks with the largest allocation to Tesla Motors (TSLA) at 2.2%  (HVOL overview and top holdings).

Russell 1000 Low Volatility ETF (LVOL) – the underlying Russell-Axioma U.S. Large Cap Low Volatility Index attempts to track stocks from the Russell 1000 with low volatility based on their variability in total returns over the last 60 days.  The fund currently holds 105 stocks with the largest allocation to Philip Morris International (PM) at 2.1% (LVOL overview and top holdings).

Russell 1000 High Momentum ETF (HMTM) – the underlying Russell-Axioma U.S. Large Cap High Momentum Index attempts to track stocks from the Russell 1000 with high momentum based on their cumulative return over the past 250 trading days excluding the most recent 20 trading days.  The fund currently holds 177 stocks with the largest allocation to National Oilwell Varco (NOV) at 2.1% (HMTM overview and top holdings).

Russell 2000 High Beta ETF (SHBT) – the underlying Russell-Axioma U.S. Small Cap High Beta Index attempts to track stocks from the Russell 2000 with high predicted beta, a measure of the sensitivity of a stock's price to changes in the base index (the Russell 2000 in this case).  The fund currently holds 140 stocks with the largest allocation to WR Grace & Co (GRA) at 2.1% (SHBT overview and top holdings).

Russell 2000 Low Beta ETF (SLBT) – the underlying Russell-Axioma U.S. Small Cap Low Beta Index attempts to track stocks from the Russell 2000 with low predicted beta, a measure of the sensitivity of a stock's price to changes in the base index.  The fund currently holds 354 stocks with the largest allocation to Unisource Energy (UNS) at 1.8% (SLBT overview and top holdings).

Russell 2000 High Volatility ETF (SHVY) – the underlying Russell-Axioma U.S. Small Cap High Volatility Index attempts to track stocks from the Russell 2000 with high volatility based on their variability in total returns over the last 60 days.  The fund currently holds 370 stocks with the largest allocation to CARBO Ceramics (CRR) at 1.9% (SHVY overview and top holdings).

Russell 2000 Low Volatility ETF (SLVY) – the underlying Russell-Axioma U.S. Small Cap Low Volatility Index attempts to track stocks from the Russell 2000 with low volatility based on their variability in total returns over the last 60 days.  The fund currently holds 198 stocks with the largest allocation to Hittite Microwave (HITT) at 2.0% (SLVY overview and top holdings).

Russell 2000 High Momentum ETF (SHMO) – the underlying Russell-Axioma U.S. Small Cap High Momentum Index attempts to track stocks from the Russell 2000 with high momentum based on their cumulative return over the past 250 trading days excluding the most recent 20 trading days.  The fund currently holds 302 stocks with the largest allocation to Jazz Pharmaceuticals (JAZZ) at 2.0% (SHMO overview and top holdings).

Conclusion

I would classify Russell's first wave of Discipline Index ETFs as retro style funds.  They follow methodologies used by many investment managers, and are based on styles that existed prior to the invention of the nine-square style-box matrix.  They are portfolio building blocks.

This second wave, the Factor ETFs, is more narrowly defined using the single factor approach.  While you could probably build a portfolio from these, I view them more as portfolio tuning and risk-management tools.  Or, if you prefer, some of the satellites in a “core and satellite” portfolio approach.

I believe both waves of products are winners, but it will take more than that for Russell to establish a foothold in this competitive marketplace.  As I alluded in my earlier review of the Discipline Index ETFs, Russell's biggest challenge will likely be marketing.

Disclosure covering writer, editor, and publisher:  No positions in any of the securities mentioned.  No positions in any of the companies or ETF sponsors mentioned.  No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.