Investors Return To Small Cap ETFs

March 29, 2016

As we approach the end of the first quarter, it seems investors are looking for opportunity in small-cap stocks.

Asset inflows into the iShares Russell 2000 (IWM | A-89)—the most popular U.S. small-cap ETF, with $25.4 billion in assets—have exceeded $1.8 billion in the past week alone, according to FactSet data.

The net creations have come despite the fund’s unimpressive performance relative to large-cap names—an underperformance that has been in place since late last summer. Consider that in 2015, IWM ended the year with nearly 4.5% in losses, while the large-cap SPDR S&P 500 (SPY | A-98) closed the 12-month period marginally higher, as the chart below shows:

So far in 2016, the story hasn’t really changed much, as IWM continues to underwhelm at a time when large-cap U.S. stocks are barely breaking even:

Charts courtesy of Stockcharts.com

But the pickup in demand for IWM—and to some extent, for other small cap funds, such as the iShares Core S&P Small Cap (IJR | A-91), which has seen net inflows of about $71 million in the past week—could be driven by the same impetus pushing up demand for emerging market stocks.

That’s namely the belief that these pockets of the market have been beaten down significantly, and could be ready to deliver outsize gains in a rally.

‘Regression To The Mean’ Trade

“It's probably a reflection of a ‘regression to the mean’ trade and/or reflection of embracing higher beta,” said Paul Weisbruch, Street One Financial’s VP of ETF/Options Sales and Trading.

“Basically, people are hoping that the market itself has re-entered ‘bull mode’ and that they may receive more bang for their buck by choosing high beta here,” he added.

This is a simple example of the risk/reward concept that’s central to investing.

So far in 2016, the prevailing mood among investors has been a defensive one. A look at the most popular ETFs so far this year shows a clear distaste for risk, and strong demand for safety via strategies that tap into gold and fixed income.

While talk of a U.S.—and global—recession this year are still circulating around markets, there are a number of economists that see no recession at all, and are calling for stronger oil prices going forward.

Higher Risk, Higher Reward

In the event of a stock market recovery, the higher the beta (the risk), the higher the potential return. If recent inflows into IWM are any indication of what’s to come, it seems investors are positioning themselves to capture some upside.

The recent creations have pushed IWM’s year-to-date asset inflows into positive territory, currently sitting at a net of $266 million. In 2015, the fund bled $1.45 billion in outflows.

Contact Cinthia Murphy at [email protected].

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