Inside Stumbling Small-Cap ETF Returns

September 25, 2014

Small-cap ETFs are struggling this year, especially those that favor the smallest firms.

U.S. large caps as represented by the SPDR S&P 500 (SPY | A-98) are up 9.3 percent for the year. Small caps reflected by the iShares Core S&P Small-Cap ETF (IJR | A-92) and the iShares Russell 2000 ETF (IWM | A-77) are down 1.3 percent and 2 percent, respectively.

I’ve included the SPDR S&P MidCap 400 ETF (MDY | A-79) for reference in the chart below too. It’s the middle ground in size, turning in a return of 5 percent so far in 2014.

YTD Return line chart

Bloomberg data, total return price, 12/31/2013 to 9/22/2014

The Receding Tide Reveals the Swimwear

Here’s what’s interesting: This period of uneven performance, while brief so far, offers insight into how the broad array of ETFs in the small-cap space perform under stress.

What stands out first is the broad range of returns to date. The difference between leader and laggard in the space year-to-date is 10 percentage points. That’s the huge spread between the iShares Morningstar Small-Cap ETF (JKJ | B-85) and the PowerShares DWA SmallCap Momentum ETF (DWAS | B-43), which turned in 3.3 percent and -7.4 percent, respectively.

Size Matters

A peek at the leaders and laggards hints at performance drivers. At the top of the year-to-date performance heap are JKJ—which I mentioned above—and the Vanguard Small-Cap ETF (VB | A-100), turning in 3.3 percent and 2.9 percent returns, respectively. These two funds at the top of the small-cap returns list share a common trait: They favor larger stocks.

To back up a step, there’s little consensus on exactly what a small-cap stock is. The names of the most popular small-cap indexes—the S&P 600 and the Russell 2000—hint at the fundamental disagreement. Are there 600 small-cap stocks out there? Or are there 2000?

More important than the number of stocks in an ETF is the set of boundaries used by each ETF’s index. In other words, after ranking every stock by market cap, how far down does the ETF’s index go before a stock is considered small-cap?





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