Why Small Cap ETFs Are Underperforming

March 17, 2017

Investors Sticking Around Small-Caps

Whatever the reason for the lagging performance relative to large-caps, the reality is that investors haven’t been bailing out on small-cap ETFs yet, for the most part.

That could have something to do either with their faith in the outlook for the segment, or with a growing acknowledgment that ignoring small-caps, globally, is ignoring about 14% of the equity investable “opportunity” in a global scale, according to MSCI data.

IJR has now attracted $3.2 billion in fresh net assets year-to-date, while the Vanguard Small-Cap Index Fund (VB) has attracted $1.8 billion in net creations year-to-date. But IWM has faced $2.3 billion in net redemptions so far this year.

Outside of U.S. small-cap exposure, funds like the iShares MSCI EAFE Small-Cap ETF (SCZ) and the Vanguard FTSE All World (ex-US) Small Cap Index Fund (VSS) have also been net gainers, raking in about $350 million and $200 million in net inflows year-to-date, respectively.

Institutional Investors Taking Notice

Small-cap stocks haven’t typically been the realm of institutional investors, but MSCI research shows that is now changing due to four trends:

  1. Small-caps historically earn a premium relative to large-caps, and that size premium is true not only in the U.S. but also globally, making domestic and international small-caps attractive.
  2. They are good diversifiers in an all-cap portfolio. They react differently in different parts of the market cycle, and are less exposed to macro global events and more exposed to domestic events.
  3. They represent about 14% of the all-cap global equity market, so not owning small-caps leaves a sizable gap in a total market allocation.
  4. Often thought to be a good spot for active managers, the reality is that these managers have not delivered consistent outperformance in the small-cap segment. Investors today are finding that index-based market-cap-weighted small-cap strategies as well as factor-based strategies focused on size fit the bill nicely, and often at a very low cost.

In the ETF market, there are more than 100 small-cap ETFs, the biggest being IWM with $36.4 billion, and IJR with $29 billion.

But the universe is diverse, with ETFs offering exposure to U.S. small-caps, global, EAFE, emerging markets, value/growth and smart-beta small-cap portfolios, each unique in their approach to the size factor.

They can all be seen in our Small Cap ETF Channel.

Contact Cinthia Murphy at [email protected]


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