The month of November has been good to U.S. small cap ETFs, with all eyes looking for signs that this early-cycle, economy-reopening-type trade has legs. News of COVID-19 vaccines being weeks away triggered the notion that smaller companies may finally be confident to deploy capital and restart growing as economic conditions improve.
But looking back at the entire U.S. stock market surge since the March 23 low, it’s been a great time for small cap ETF investors.
Consider the bellwether in this space, the iShares Russell 2000 ETF (IWM). So far in November, the fund has rallied almost 16%, outpacing large caps, as measured by the SPDR S&P 500 ETF Trust (SPY), by 5 percentage points.
Go back to March 23, when the U.S. stock market forged a low point, and the performance difference is even more striking, widening recently to 17 points:
Investing in IWM means owning a portfolio of about 2,000 stocks, with a weighted average market cap of only $2.5 billion. Compare that to SPY’s portfolio average of $455 billion, and you get a sense of just how small these companies are.
Leading the financials- and health-care-heavy portfolio are companies like MyoKardia, Mirati Therapeutics and Caesars Entertainment.
(Use our stock finder tool to find an ETF’s allocation to a certain stock.)
Plenty Of Choices
There are many interesting ways to access this segment. There are 128 small cap ETFs on the market, many focused on the U.S. market, each offering all sorts of exposure.
Here are a few sample pairings and the difference in outcomes they’ve each delivered in the March-23-to-date period.
(Please note that you can use our free ETF Comparison Tool to plot each of these ETF pairs side by side for a complete look at portfolio construction differences and other details.)
IWM, tracking the Russell 2000, may be the most popular small cap ETF today, but it’s practically tied for biggest when it comes to total assets under management. Both IWM and the iShares Core S&P Small-Cap ETF (IJR) have total assets hovering at $48 billion.
Each of these funds offers market-cap-weighted vanilla access to small caps stocks as defined by two different index providers, both popular with investors. The difference is the index brand. FTSE Russell and S&P Dow Jones are just two index providers—there are many more.
If you are going to slice your equity sleeve across various segments, size and style, factors, etc., you may want to be thoughtful about your underlying indexes. Sometimes sticking to one family of indexes—one index provider—helps you avoid gaps or overlap in exposure from different methodologies.
There are other key differences to consider. IWM holds some 2,000 stocks, IJR owns only 600. How much diversification do you want in small caps? Also, IWM tilts a little larger, with a weighted market cap of $2.5 billion, while IJR’s average sits at $1.8 billion.
More importantly, IJR’s expense ratio is a lot cheaper, at 0.06%, IWM’s 0.19%. That said, if you are going to be trading your ETF, IWM can’t be beat on that front. The fund trades more than $3.8 billion on average a day at pennywide spreads. That’s 10x the daily volume of IJR.
Since March 23, IWM has bested IJR in performance, and both have handily beaten the S&P 500:
- Small Cap Value Vs. Small Cap Growth
The battle of value versus growth is one we all know well. In 2020, growth stocks have led the way most of the time, but in recent weeks, a lot of attention has been paid to the emergence of small cap value as leader. No matter what side of the divide you sit on, there’s an ETF for that.
One popular pairing in this space is the Vanguard Small-Cap Value ETF (VBR) and the Vanguard Small-Cap Growth ETF (VBK). Both funds track CRSP indexes, which, in this segment, tilt a little larger than most, extending into the midcap space, according to FactSet data. And both charge just 0.07% in expense ratio.
VBR invests in small cap stocks based on five value factors. The focus on value means the portfolio is currently heavily tilted toward financials and industrials, which together represent about 45% of the fund’s sector allocation. The portfolio’s average market caps is $4.8 billion—larger than some broad vanilla approaches.
By comparison, VBK, which relies on various metrics to pick and weight growth names, has less than 600 securities, and tilts even larger, with a weighted average market cap of about $7 billion. Not surprising, VBK is dominated by technology and health care names, which represent more than half the portfolio.
Both the $15.5 billion VBR and the $12.7 billion VBK, as small cap portfolios, have outperformed SPY since March 23. But VBK has led the pair, as growth stocks have had a much better year (thus far) than value stocks, but VBR has put up a good fight in recent days:
- Equal-Weighted Vs. Fundamental Strategies
Equal weighting or fundamental selection and weighting methodologies are all different colors of the smart beta spectrum of ETF possibilities.
The Invesco S&P SmallCap 600 Equal Weight ETF (EWSC) offers access to the S&P 600 names—the same basket as one of the biggest small cap ETFs, IJR—but it equal-weights holdings. The approach reduces single-stock risk—which isn’t that much bigger in IJR’s broad portfolio—and it also gives the portfolio a tilt toward smaller, micro-cap names.
By comparison, the Schwab Fundamental U.S. Small Company Index ETF (FNDA) is built around a fundamentally selected and weighted Russell index. The strategy takes into account several fundamental metrics, some pointing to value, yield and even the overall quality of a company, such as cash flow, sales, dividends and buybacks.
The resulting portfolio of some 900 stocks doesn’t make any big sector bets. Like most, including EWSC, FNDA is led by financials, consumer discretionary and industrial stocks.
Perhaps notable on FNDA’s top 10 holdings is that Tesla (TSLA)—which you might not have expected to see here—and First Solar (FSLR) are among them.
These two vastly different takes on the small cap equity universe—one using a simple weighting methodology to dilute risk and the other looking to fundamentals for guidance—have one thing in common: They have both outperformed IJR since March 23, and equal-weighted EWSC has outperformed IWM as well:
- Battle Of Low Volatility Small Caps
Small cap stocks are known as risky fare, which is why some risk-averse investors like the idea of a low volatility strategy.
The Invesco S&P SmallCap Low Volatility ETF (XSLV) is one of the options. The $1.5 billion fund is a pure play low vol strategy by design, relatively concentrated in a portfolio of about 120 stocks.
The fund picks the 120 least volatile stocks in the S&P Small Cap 600 universe, and weights them inversely by volatility, so that the least volatile carry the most weight. This is straightforward portfolio construction with a clear goal.
XSLV is led by financials at 23% of the portfolio, like many small cap ETFs, but technology stocks represent almost 20% of the mix. That sets it apart. Top holdings include WD 40 Company, Shutterstock and MicroStrategy Inc.
The SPDR SSGA U.S. Small Cap Low Volatility Index ETF (SMLV) goes about it differently. The broader portfolio of more than 400 stocks chooses and weights stocks based on 12 months’ worth of low volatility and other factors. The end result is a mix that carries almost 2x the exposure to financials than XLSV—45%—and just under half the exposure to technology, at 9%.
Since the market low of March 23, XSLV’s purer low vol approach has under-delivered. The market has not rewarded the low vol factor this year. SMLV has outperformed.
- Alpha-Seekers: Active Vs. Veteran Smart Beta
One final example of ways to access small cap stocks outside of the plain vanilla bucket is through alpha-seeking strategies.
The first is a smart beta approach known as AlphaDEX from First Trust, and the other a relatively new fund from a growing lineup of actively managed Avantis ETFs.
AlphaDEX is a quantitative strategy that considers fundamental and technical factors in its selection and weighting schemes in search of outperformance. The First Trust Small Cap Value AlphaDEX Fund (FYT) takes an additional step to focus on the value factor, all relative to the S&P 600 universe.
FYT isn’t cheap, costing 0.72% in expense ratio, but First Trust has a loyal following of investors across its lineup of ETFs, and it’s delivering results. FYT is up nearly 100% since March 23. That’s more than 25 percentage points of outperformance relative to the S&P 600-focused IJR.
The Avantis U.S. Small Cap Value ETF (AVUV) is also in the business of pursuing outperformance, and it does so by relying on an active manager who searches the small cap equity universe for stocks with low valuations and high profitability.
Its mix of about 500 stocks, led by financials and consumer discretionary names, is surprisingly cheap for an active ETF, costing only 0.25% in expense ratio. That’s one aspect of the fund’s appeal with active investors used to far higher fees.
AVUV, too, has had a stellar run so far this year, rallying 91% since March 23:
Charts courtesy of Stockcharts.com
At the end of the day, individual holdings, sector allocations, expense ratios, overall costs and focus all matter in performance, risk profile and investor experience.
There’s no one-size-fits-all strategy, but there is plenty of choice, with 128 different small cap ETFs.
Contact Cinthia Murphy at [email protected]