Choosing AVUV Over IJS for Stronger Small-Cap Value Factor Exposure

The small-cap value segment of the U.S. equity market has long been a battleground for investors seeking to harness the "factors" that drive long-term returns. For factor-focused investors, the choice between actively managed and passive strategies often hinges on a delicate cost-benefit analysis. The Avantis U.S. Small Cap Value ETF (AVUV) and the iShares S&P Small-Cap 600 Value ETF (IJS) represent two prominent approaches to this asset class. While IJS offers the familiar appeal of passive indexing, AVUV's active, rules-based strategy delivers superior factor purity in size, value, profitability, and quality-justifying its higher expense ratio, particularly for investors holding the fund in tax-advantaged accounts.

Factor Purity: AVUV's Strategic Edge

Factor investing thrives on precision. A fund's ability to isolate and amplify exposure to specific factors-such as size (small-cap tilt), value (low price-to-book ratios), and profitability (high operating margins)-directly impacts its long-term performance. AVUV's active management strategy employs a rigorous, rules-based screen to identify small-cap stocks that combine low valuations with strong profitability, effectively avoiding "value traps" that drag down returns. In contrast, IJS passively tracks the S&P SmallCap 600 Value Index, which emphasizes size and value but includes weaker-quality companies that fail to meet AVUV's profitability thresholds.

Data from recent analyses underscores this divergence. AVUV demonstrates stronger loadings on the Size and Profitability factors compared to IJS, making it a more concentrated vehicle for investors seeking these exposures.

While both funds emphasize small-cap value, AVUV's exclusion of low-quality stocks enhances its alignment with academic research showing that profitability is a critical differentiator within value strategies. For investors prioritizing factor purity, this distinction is not trivial-it is foundational.

Cost-Benefit Analysis: Justifying the Premium

AVUV's 0.25% expense ratio is higher than IJS's historical 0.18%, though recent data indicates the two funds now share the same 0.25% cost structure. This convergence reflects IJS's competitive response to AVUV's market success. However, the cost-benefit calculus extends beyond the expense ratio. Over three- and five-year horizons, AVUV has delivered annualized returns of 12.31% and 12.82%, outpacing IJS's 8.48% and 7.60%. These results align with the long-term advantages of active factor tilting, where higher upfront costs are offset by stronger risk-adjusted returns.

Critics may point to IJS's recent 5.40% year-to-date return versus AVUV's 4.96%, but short-term performance is an imperfect metric for factor strategies. Passive funds like IJS are inherently constrained by index inclusion, which dilutes exposure to weaker stocks. AVUV's active screens eliminate such drag, a trade-off that pays dividends over multiyear cycles. For investors with time horizons exceeding five years, AVUV's higher expense ratio is a small price to pay for its ability to compound returns through purer factor exposure.

Tax Efficiency and Strategic Positioning

While direct data on tax efficiency remains sparse, AVUV's active management likely results in higher portfolio turnover compared to IJS. However, this drawback is mitigated for investors holding AVUV in tax-advantaged accounts, such as IRAs or 401(k)s. In such vehicles, the tax cost of higher turnover is neutralized, allowing AVUV's factor purity to shine without the drag of realized capital gains. Conversely, IJS's passive structure inherently generates lower turnover, making it a more tax-efficient choice for taxable accounts. Yet for investors prioritizing factor exposure over immediate tax savings-and who can allocate AVUV to tax-advantaged accounts-the active fund's strategic advantages dominate.

Conclusion: A Case for Active Factor Tilting

The debate between active and passive management in small-cap value investing is not a zero-sum game. For investors whose primary objective is to capture the premiums associated with size, value, and profitability, AVUV's active strategy offers a compelling case. Its rigorous screens for quality and profitability, combined with its ability to outperform over multiyear cycles, justify its expense ratio-particularly when positioned in tax-advantaged accounts. IJS, while a reliable and cost-competitive alternative, cannot match AVUV's factor purity or long-term compounding potential. In an era where passive strategies increasingly dominate, AVUV stands as a testament to the enduring value of active, rules-based factor investing.