There are better alternatives.

by Alex Bryan
iShares Russell 2000 Value

Despite its cost advantage over its actively managed counterparts, iShares Russell 2000 Value ETF IWN earns a Morningstar Analyst Rating of Neutral. It starts at a disadvantage relative to its closest index peers because its parent index will likely suffer from a larger rebalancing drag, which can hurt performance, and there are cheaper index alternatives. Like most its index peers, this strategy does not make any sector adjustments in its stock selection approach, which introduces persistent sector tilts that may not be well-rewarded over the long term.

The fund targets stocks representing the cheaper and slower-growing half of the Russell 2000 Index and weights them by market capitalization, which reflects the market’s collective wisdom about their relative value. Small-value stocks are not necessarily bargains, since they are growing more slowly than their pricier counterparts. The fund does not take any steps to avoid stocks whose low valuations mask deteriorating fundamentals. But it stays out of trouble through broad diversification and market-cap weighting. 

Because it casts a wide net, the fund includes stocks with modest value characteristics. About one fourth of the fund's holdings overlap with its growth counterpart, iShares Russell 2000 Growth ETF IWO. Even with these holdings, it has a value orientation that's comparable to the small-value Morningstar Category average, though it climbs slightly further down the market-cap ladder.

The fund's parent index, the Russell 2000, will likely suffer from greater market-impact costs of rebalancing than other small-cap indexes. This is because there is a lot of money tied to it, creating a large demand for liquidity that can move prices when there are changes to the portfolio. The index also has considerable exposure to micro-caps that tend to be more expensive to trade, and it does not apply buffer rules to limit turnover among its smallest constituents. This puts the fund at a disadvantage to its index peers. During the trailing 10 years through February 2019, it lagged the MSCI USA Small Value, CRSP U.S. Small Cap Value, and S&P SmallCap 600 Value indexes by 1.07 percentage points annually.

Portfolio Construction

The fund employs full replication to track the Russell 2000 Value Index. This index effectively diversifies risk and accurately reflects the composition of its target market segment. But it starts at a disadvantage because the Russell 2000 Index, which comprises its selection universe, will likely continue to suffer from a larger rebalancing drag than its peers. Therefore, the fund earns a Neutral Process Pillar rating. Russell assigns a composite value score to each stock in the Russell 2000 Index using one value metric (price/book) and two growth metrics (I/B/E/S medium-term growth forecast and five-year historical sales per share growth). The two growth attributes receive the same weighting in this calculation as the single value variable. Russell fully allocates stocks representing 25% of the assets in the Russell 2000 Index with the lowest composite value scores to the growth index and the highest 25% to the value index. It partially allocates stocks that fall in between these cutoffs to both the value and growth indexes, based on the relative strength of the stock's value and growth characteristics. Together, the value and growth indexes represent 100% of the assets of the Russell 2000 Index. Russell reconstitutes the fund's benchmark annually in June.


The fund charges a 0.24% expense ratio, which is low relative to the small-value category, supporting the Positive Price Pillar rating. However, there are cheaper index alternatives. The managers generate ancillary income for the fund through securities lending, which helps offset its expenses. As a result, the fund only lagged its benchmark by 8 basis points annually during the trailing three years through February 2019.

S&P 500 index data: S&P 500 Copyright @ 2019

All data from Morningstar except U.S. intraday real-time exchange quotes, which are provided by BATS when available. End-of-day quotes for Nasdaq, NYSE, and Amex securities will appear 15 minutes after close. Graph times are Eastern Standard. @ Copyright 2019 Morningstar, Inc.