A Better Way to Bet on Growth Stocks

TheStreet.com

NEW YORK (TheStreet) -- Growth stocks have been outdoing value lately, and plenty of financial advisors think the trend will continue. With the economy sluggish, investors will gravitate to companies with reliable earnings, advisors argue. If you want to emphasize growth, you can buy an ETF like SPDR S&P 500 Growth SPYG or Vanguard Growth VUG

For even more juice in a growth rally, consider a pure fund like Guggenheim S&P 500 Pure Growth RPG or iShares Morningstar Large Growth JKE . "If you decide to bet on growth--and you have a lot of conviction--then pure funds are the way to go," says Matt Hougan, president of ETF analytics for IndexUniverse.com.

Pure funds provide a concentrated dose of an asset class. That can boost returns when the sector rallies. During the rebound of 2009, the Guggenheim pure ETF rose 50.1%, while the conventional SPDR S&P 500 Growth returned 37.1%. Whether or not they lead over the short-term, the pure funds can make sound choices for investors who are looking to emphasize a sector or diversify a portfolio.

Besides pure growth funds, companies have also introduced pure value ETFs. Those tend to outperform when value stocks lead the markets. Choices include PowerShares Fundamental Pure Large Value PXLV and Guggenheim S&P Smallcap 600 Pure Value RZV . When small value funds soared in 2010, the Guggenheim pure fund returned 28.6%, compared to 24.7% for iShares S&P SmallCap 600 Value IJS , a conventional fund.

Some of the pure funds have recorded sound long-term track records. During the past five years, Guggenheim S&P 500 Pure Growth returned 4.1%, compared to 2.7% for the conventional SPDR growth fund. But pure funds tend to trail conventional peers when their sector is out of favor. If value leads for the next five years, then the pure growth funds could be laggards.


Pure funds can deliver extra juice because of their unusual construction. To build growth and value portfolios, conventional funds divide the universe roughly in half. Stocks with faster earnings or higher prices go in the growth basket, while lower-priced shares go into value. But some stocks have a mix of growth and value traits. These blend stocks can be placed in both growth and value funds. The blend group includes such familiar names as Exxon Mobil XOM and Microsoft MSFT , which are in both SPDR S&P 500 Growth and SPDR S&P 500 Value SPYV .

The blend stocks can hold back a growth fund when the sector is rallying. To avoid the drag, pure funds eliminate blend stocks entirely. So all the holdings in pure growth funds have clear growth characteristics. As a result, the pure growth portfolios tend to have higher prices. The price-earnings ratio for the pure iShares Morningstar Large Growth is 17.6, compared to a figure of 15.8 for the conventional SPDR S&P 500 Growth. Besides being more expensive, the pure growth funds tend to have higher earnings growth and more volatility. Pure value funds have lower P/Es than conventional competitors.


Some pure funds are also different because of how they weight holdings. Conventional funds weight stocks in their portfolios according to market capitalization. So stocks with bigger market values have heavier weightings. As result the top holdings in SPDR S&P 500 Growth include such giants as International Business Machines IBM , Johnson & Johnson JNJ and Coca-Cola KO . Instead of weighting by market cap, the Guggenheim pure growth funds give the greatest weight to stocks with the strongest growth characteristics. So the top holdings include companies with rapid earnings growth, such as biotech star Alexion Pharmaceuticals ALXN and online travel site Priceline.com PCLN . Such stocks can surge in growth rallies, but they can also sink hard. When stocks dropped in the third quarter of 2011, Guggenheim Pure S&P 500 Growth fell 16.8%, compared to a decline of 11.0% for SPDR S&P 500 Growth.

Because they emphasize stocks with the most extreme growth or value characteristics, the pure funds often give heavy weightings to certain sectors. With financials remaining depressed, Guggenheim S&P 500 Pure Value RPV has 37.1% of assets in the sector, while SPDR S&P 500 Value SPYV only has 24.1% in financials. For the pure funds, the big sector weightings can boost returns during the times when value stocks soar.

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