My pick for the best exchange-traded-funds of 2020 admittedly got off to a rough start. The stock market plummeted in March, and my choice for the best ETFs — small-cap growth companies — got hammered. However, the iShares Russell 2000 Growth ETF (NYSEARCA:IWO) has mounted a swift and complete recovery. The IWO ETF reached new all-time highs in September, and is now sitting on a 5% gain year-to-date.
Both the swift drop and equally impressive recovery make sense in light of the novel coronavirus. The IWO ETF is loaded up with dynamic smaller-sized growth firms. IWO is heavily skewed toward technology, biotech, healthcare and other rapidly emerging portions of the economy.
Not surprisingly, investors ditched these stocks in March. When you own a small software or biotech company, for example, you’re thinking about where the business will be in five or ten years. The appeal is that you own companies that can potentially transform their industries. All those “if you invested $10,000 and held for decades” stories involve small companies that grew into giants. However, in a panic, people stop thinking about the long-term, and they sell anything that isn’t stable now.
You can make plenty of money buying a large company which continues to prosper. But if you want life-changing returns, it generally pays to go fishing among smaller companies with high growth rates and large addressable markets. Of course, there is often more risk with buying these sorts of companies. Hence the IWO ETF, which splits the difference by taking a diversified stake in hundreds of such companies.
The Small-Cap Advantage
In general, small-cap stocks have historically outperformed their larger company peers. It doesn’t always work, and there are significant periods of time when small-caps lag. However, in general, smaller companies are simply able to grow faster and have larger market opportunities to expand into.
This is particularly true after recessions. Earlier this year, Michael Binger of Gradient Investments noted that: “When you look historically, as the economy comes out of a recession — and we’re certainly going to be in a recession after the second quarter — small caps have outperformed large caps in nine out of the last 10 economic downturns coming out of those downturns.”
Nine out of ten are some pretty good odds. And, so far, small-cap stocks — at least of the growth variety — are delivering compelling returns since the March lows. The IWO ETF is up 74% from its bottom earlier this year.
IWO Top Holdings: Some Key Examples
Now that we’ve established why small-caps are worthy as a group, let’s look at some of the IWO ETF’s top holdings right now. What’s driving this ETF in particular?
As of this writing, the top holding is Churchill Downs (NASDAQ:CHDN). The owner of the iconic Kentucky Derby might seem like an odd pick. However, Churchill Downs has invested in online gaming, and now has leading betting sites such as TwinSpires. That, plus the upcoming return of live horse racing has added up to a winning formula; shares have tripled off the Covid-19 lows and are up 24% year-to-date.
You know how Costco (NASDAQ:COST) has been doing great this year? If you own IWO, you’re benefiting from the warehouse trend, as rival BJ’s Wholesale (NYSE:BJ) is a top holding. BJ’s stock has already doubled this year, yet still trades at just 17x earnings. That’s far more attractive than Costco from a valuation perspective.
IWO is also riding the housing boom as it has top 10 positions in Restoration Hardware (NYSE:RH) and SiteOne Landscape Supply (NYSE:SITE). In healthcare, IWO has a bunch of top holdings, including iRhythm (NASDAQ:IRTC) and Momenta Pharmaceuticals (NASDAQ:MNTA). If you don’t have the time or desire to research all these smaller companies individually, the IWO ETF is a great way to get a piece of all of them within one fund.
Is the IWO ETF Still Among the Best ETFs?
The tables have turned. Just six months ago, folks were wondering if small-cap growth was still viable in an economy rapidly plunging into a sharp recession. Now small-cap growth stocks are back at all-time highs and the worries are focused around valuation.
And that’s fair; earnings are down this year for most companies, yet the stock prices for growth names are surging again. However, if you’re going to pay up, I’d argue that there’s more opportunity in the small-caps than the FAANG stocks and other large-cap names. The pandemic has caused many permanent changes in the economy. These changes will benefit nimble fast-moving companies. A bunch of small software, internet, biotech and healthcare companies saw their business outlooks radically improve this year.
In owning the IWO ETF, you get exposure to some of the most innovative companies in the country. And at only 5% more expensive than last year, IWO is still a reasonably priced way to get that exposure. It certainly beats chasing many of the software or e-commerce stocks that have already doubled or tripled this year. All of these elements stack up to make it one of the overall best ETFs.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.