Among domestic equities, small-caps have been the place to be this year. The iShares Russell 2000 ETF (NYSARCA:IWM), the largest exchange-traded fund (ETF) dedicated to smaller domestic stocks, is up nearly 9% year-to-date while the large-cap S&P 500 is higher by just 1.8%.
A slew of other small-cap ETFs are delivering better performances than the broad-based IWM, underscoring the strength seen across the wider universe of smaller equities. And there are several reasons why small-cap ETFs can continue outpacing their large-cap peers.
First, small-caps typically perform better than large-caps when interest rates rise and the dollar strengthens, as is happening in the current environment. The reason being is that smaller companies are usually more dependent on the U.S. as their primary source of revenue whereas large-cap multinationals across multiple sectors derive substantial portions of their sales overseas.
On a related note, the notion of intensifying trade wars between the U.S. and other major economies are weighing on large-cap stocks, but small-cap ETFs are remaining steady, owing to the largely domestic focus of smaller companies.
Consider some of the following small-cap ETFs for access to the benefits of the size factor.
Small-Cap ETFs: O’Shares FTSE Russell Small Cap Quality Dividend ETF (OUSM)
Expense Ratio: 0.48% per year, or $48 on a $10,000 investment.
It is possible to generate income via small-cap ETFs, and the O’Shares FTSE Russell Small Cap Quality Dividend ETF (NYSEARCA:OUSM) is one such example. OUSM’s underlying index “is designed to reflect the performance of publicly listed small-capitalization dividend-paying issuers in the United States exhibiting high quality, low volatility and high dividend yields,” according to O’Shares.
This small-cap ETF’s factor-based strategy helps minimize volatility (small-caps are usually more volatile than large-caps) and identify smaller companies with the potential to steadily deliver and grow dividends. OUSM’s quality focus also steers investors away from some high-dividend companies that may be financially challenged and on the brink of negative dividend action.
The industrial, financial services and consumer discretionary sectors combine for over 58% of OUSM’s weight.
OUSM’s top holdings generate 81% of their revenue on a domestic basis compared to 55% for S&P 500 companies, according to issuer data.
Small-Cap ETFs: iShares Micro-Cap ETF (IWC)
Expense Ratio: 0.6%
For investors willing to take on a little more risk with their small-cap ETFs, the iShares Micro-Cap ETF (NYSEARCA:IWC) is worth a look.
Micro-caps are usually defined as stocks with market values ranging from $50 million to $300 million. While it may appear that there is more risk involved with micro-caps than traditional small-caps, IWC’s three-year standard deviation is 15.6%, which is not much higher than the 14.1% on the aforementioned IWM. Plus, IWC is rewarding investors for taking on the added risk this year with a gain of more than 12%.
“Being more domestic has insulated micro caps from trade tensions, geopolitical worries and the earnings drag stemming from a stronger dollar,” according FTSE Russell, IWC’s index provider. Being less global also gives micro-caps more exposure to several positives including tax reform, increasing deregulation and faster U.S. economic growth relative to weaker recoveries in Europe and Japan.
All these tailwinds are helping drive faster profit growth for micro-caps relative to their blue-chip counterparts, helping fuel YTD leadership.
Small-Cap ETFs: Invesco S&P SmallCap 600 Pure Value ETF (RZV)
Expense Ratio: 0.35%
Over the long-term, the marriage of small-caps and the value factor is potent. The Invesco S&P SmallCap 600 Pure Value ETF (NYSEARCA:RZV) proves as much, as this small-cap ETF is one of the best-performing funds of any stripe during the current bull market in U.S. stocks.
As RZV’s year-to-date performance proves, smaller value stocks can surge while large-cap equivalents struggle. This small-cap ETF is up 7% year-to-date while the large-cap S&P 500 Value Index is lower by more than 4%.
Usually, large-cap value strategies are heavily allocated to energy and financial services stocks, but RZV departs from that normal. RZV allocates nearly 51% of its combined weight to the consumer discretionary and industrial sectors. None of the ETF’s 165 holdings account for more than 1.5% of its weight.
Small-Cap ETFs: Schwab U.S. Small-Cap ETF (SCHA)
Expense Ratio: 0.05%
Investors looking for basic, cost-effective small-cap exposure can consider the Schwab U.S. Small-Cap ETF (NYSEARCA:SCHA). Home to over 1,700 stocks, SCHA tracks the Dow Jones U.S. Small-Cap Total Stock Market Index.
This small-cap ETF’s modest expense ratio of just 0.05% per year makes it one of the least expensive ETFs in its respective category. Schwab clients can further reduce expenses associated with SCHA because the broker offers the small-cap ETF commission-free.
A point to note with SCHA, and this is a condition that pertains to other small-cap ETFs, is that the fund is actually heavily allocated to mid-cap stocks. Mid-caps account for over 46% of SCHA’s roster.
Mid-caps offer solid outperformance potential in their own right, but more pure small-cap benchmarks, such as the Russell 2000 and the S&P SmalCap 600 Index, have outperformed SCHA over the past three years.
Todd Shriber does not own any of the aforementioned securities.
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