Small, Midcap Equity ETFs May Boost Portfolios

In what appears to be a contrarian bet, investors hunting for returns in the current market turmoil are piling into small and midcap equity exchange-traded funds, which appear to be weathering the current situation better than their larger, more volatile, counterparts.  

Small and midcap equity funds brought in $4.8 billion in the first two months of the year, according to Bloomberg data, compared with the nearly $11.4 billion that exited large cap equity funds during the same period.  

Heightened volatility and seesawing markets following the second and third largest U.S. banking failures last week has sent rattled investors to cash alternatives or to scout new investment opportunities for both safety and returns.  

One sidestep might be to invest in midcap stock funds, according to Dina Tang, head of Global Index Portfolio Management at Franklin Templeton ETFs.  

“If you invest in midcap, you can find the best of both worlds,” she said in an interview with etf.com. “You have companies [that] are the leaders in that particular area, but they tend not to be mega tech companies.”  

Midcap companies aren’t as affected by financing concerns as small cap names, she said, adding that midcaps tend to be more diversified and impacted less by currency fluctuations and global downturns than large caps. 

Year to date, midcap funds like the Vanguard Mid-Cap ETF (VO) and the SPDR S&P MidCap 400 ETF Trust (MDY) have inched up 1.2% and 1.7%, respectively.  

Small cap funds may also be a segment to watch, as their inflows outpace larger counterparts. Small cap equity ETF brought in $11 billion more than large cap funds in February, Matt Bartolini, head of SPDR Americas Research, wrote in a note earlier this March. The relatively smaller funds pulled in $2.3 billion in February, while large caps had outflows of $8.9 billion, the note reads.  

“The preference for small and inexpensive exposures does showcase that investors are favoring different submarkets with US equities,” Bartolini wrote. “Altogether, this indicates that investors really just dislike US large cap and US growth exposures—likely a result of valuation concerns as small caps, most notably, do not have those same issues.”  

Earlier this year, both Bartolini and Michael Arone, chief investment strategist at State Street, noted how small cap names “haven’t witnessed the same degree of negative earnings sentiment.” They added “if a policy pivot turns market pessimism to optimism and risk aversion declines,” segments, such as small cap stocks, may be enticing.  

Small cap funds like the Schwab U.S. Small-Cap ETF (SCHA), the Dimensional U.S. Small Cap ETF (DFAS) and the Principal U.S. Small-Cap Multi-Factor ETF (PSC) have all jumped more than 1% year to date, according to etf.com data. So far this year, the SPDR S&P 500 ETF Trust (SPY) has gained less than 1%, while it’s lost $17 billion, according to etf.com data. 

Contact Shubham Saharan at [email protected]