**Have midcap value ETFs been less tax efficient than their large and small cap value counterparts?**

Its often argued the mid-caps are less tax efficient as they have turnover and both end – ie. from mid to large and from small to mid. To try to answer this question I looked at two sets of performance numbers for the iShares Russell and S&P series respectively as they both have performance numbers for the past five years.

For the Russell series

- - Turnover of the midcap value ETF was much lower than for small value.

- The tax cost ratio for the midcap value ETF was lower than both large value and small value (although for the latter only marginally so) – perhaps due to its relatively lower dividend yield and relatively high QDI.

- The % underperformance relative to the corresponding index was lowest for midcap value – relative to large and small cap value and similar to large cap market (ie. Russell 1000).

- So it seems the iShares Russell Midcap value has been relatively tax efficient.

- - Turnover of the midcap value ETF was almost directly in the middle of the turnover for large and small cap value.

- The tax cost ratio for the midcap value ETF was higher than the small value ETF, but lower than large value).

- It is quite striking that the iShares S&P600 has been the most tax efficient of the 4 S&P series included in the table below (more so than the iShares 500, 500 value and 400 value ETFs). It has low dividend yield and high QDI.

- The % underperformance of the corresponding index was lowest for small cap value – relative to large and mid cap value – although only marginally so for the latter.

- So it seems the iShares S&P 400 value has been relatively tax efficient (relative to the iShares S&P500 and S&P500 value), but not more so than the iShares S&P600 value.

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```
iShares Russell iShares S&P
1000 1000v MidCapV 2000v 500 500v 400v 600v
Tikker IWB IWD IWS IWN IVV IVW IJJ IJS
Turnover
2003 5 20 24 45 5 22 11 14
2004 5 12 11 16 2 5 11 12
2005 5 15 20 23 6 5 10 13
2006 7 7 10 14 7 7 21 16
2007 7 14 24 36 5 20 21 28
Average 2003-07 6 14 18 27 5 12 15 17
Tax-cost ratio 0.35 0.47 0.42 0.43 0.36 0.40 0.34 0.27
Dividend Yield 1.7 2.5 2.2 2.3 1.8 1.4 2.0 1.5
QDI 2006 100 100 89 69 100 100 88 94
5yrs to end Sept 2005
Index Return 16.0 18.1 21.0 18.7 15.5 18.2 19.6 18.4
After-tax Return 15.4 17.3 20.3 17.9 14.9 17.5 18.9 17.8
Difference -0.6 -0.8 -0.8 -0.8 -0.5 -0.7 -0.7 -0.6
% index return lost -3.5 -4.3 -3.6 -4.2 -3.6 -3.8 -3.4 -3.3
Source: Derived from information on the iShares website.
```

Assuming the above relative tax efficiency continues, IMO a midcap value:microcap combination does a reasonable job at targeting value and size exposure. Consider the two portfolios below, by my best estimate, both have similar size and value loads – around 0.3 and 0.4 respectively (the size load is slightly higher on P2 than P1 – closer to 0.4).

P1

25% Vanguard TSM

50% iShares Russell MidCap Value

25% Bridgeway Ultra Small Company Market

P2

50% Vanguard TSM

50% DFA Small Value

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```
2002-2006
Annualized Standard
Return Deviation Sharpe
P1 15.24 18.53 0.688
P2 13.21 19.97 0.547
```

Using data from 1996-2006 for some of the indexes

P1

25% TSM

50% Russell MidCap Value

25% CRSP10

P2

50% TSM

50% DFA Small Value

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```
1996-2006
Annualized Standard
Return Deviation Sharpe
P1 14.14 15.90 0.717
P2 13.42 16.20 0.665
```

IMO the main reason for the historical outperformance of the DFA small value fund is due to its higher size loading relative to comparators (i.e. it includes microcaps which have performed well relative to other size deciles over recent years). If a portfolio is constructed to get similar microcap exposure then IMO returns will be similar. This can be done, arguable with more control, with a mid-cap value and micro-cap combination (as many small value funds don't have exposure to micro-caps). For example the median market cap of the DFA small value fund is $171m, while for the Russell 2000 value it is $615m.

So from the above, IMO a Russell midcap value:Bridgeway ultra-small company market combination is a reasonable way to target value and size exposure. The resulting performance will likely get very close to the returns of some of the DFA fund combinations (for those targeting US value tilts of about 0.5-0.6 and under). It would have been good to assess the tax efficiency of the MSCI midcap value but we don’t yet have much data.

Robert

.