Small cap stocks were one of the best-performing asset classes in 2013 because of their strong growth-oriented focus and upside potential. These companies are often seen as fertile development opportunities because they have a closer affinity with new technology, research, and product innovation. Smaller companies are often able to switch directions and adapt to changes in the economy, leadership, products, and consumer demand faster than larger companies.
In addition, small companies are excellent takeover targets for larger companies that are looking to incorporate new technologies or services into their infrastructure. This can create a great deal of value for shareholders in the smaller company, as most purchases typically involve a hefty premium to the current share price.
Most investors are familiar with the iShares Russell 2000 ETF
(NYSEARCA:IWM) which tracks a broad index of stocks with market capitalizations of less than $2 billion. Last year, this ETF returned a staggering 38.85% total return, which bested the major market averages. While IWM represents an excellent way to get core exposure
for your portfolio in a diverse selection of small cap companies, it is really just a plain-vanilla index.
Today’s savvy investors may be looking for a unique spin on small cap investing, which is why I have identified two ETFs with distinctive characteristics to consider.
The first opportunity is the PowerShares DWA Small Cap Momentum Portfolio
(NYSEARCA:DWAS), which is a relative newcomer to the ETF scene, having been launched in mid-2012. Since that time, the fund has amassed nearly $650 million in assets by implementing a security selection approach that narrows the field considerably. DWAS is based on the Dorsey Wright SmallCap Technical Leaders Index, which selects 200 securities with the highest relative strength compared to their peers. "Relative strength" characteristic is defined as recent market performance.
In 2013, DWAS returned 49.19%, which is a considerable boost above the benchmark IWM. A fund such as this is bound to outperform in a year like 2013 where money poured into equities with little corrective action. The lack of volatility and concentrated approach played to its strengths by selecting high-beta stocks in strong uptrends. If 2014 proves to be a similar type of market, this fund would likely perform quite well once again. I would recommend this ETF for growth-oriented investors that are looking to supercharge their small cap exposure.
For comparative purposes it is worth noting that the expense ratio on DWAS is listed at 0.61%, which is quite a bit higher than the 0.25% fees that IWM charges. ETF providers oftentimes charge higher fees for unique index-construction methodologies, which are worth paying as long as you are getting a marked uptick in total return. Funds that charge high fees and underperform should be jettisoned from your portfolio.
The second ETF that deserves your attention is the WisdomTree SmallCap Dividend Fund
(NYSEARCA:DES). This ETF is created via a fundamentally weighted methodology that selects some of the highest dividend-paying small cap companies within the WisdomTree Dividend Index. The end result is a diversified basket of nearly 700 stocks that are focused on returning cash flow to shareholders.
In 2013, DES gained 36.16%, which slightly lagged the total return of IWM. However, the advantage of this strategy is that income-oriented investors can access a high-growth equity ETF with a 30-day SEC yield of 2.73%. That’s more than double the current 1.18% yield of IWM. In addition, the dividends in this ETF are paid monthly which many investors prefer over quarterly distributions.
According to Index Universe
, DES raked in more than $400 million in new assets in 2013 to bring its grand total to over $1 billion. On the expense side, DES charges a more modest 0.38% management fee that is reasonable when compared to its peers.
The bottom line is that both of these funds offer outside the box styles that may resonate with aggressive growth or income investors. Selecting the right one will depend on your risk tolerance and investment objectives. With the market close to its all-time highs, it may make sense to purchase these ETFs on a pullback to enter at a more advantageous cost basis. In addition, I always recommend setting a stop loss or implementing a sell discipline to define your risk in the event that the bull market takes a breather.
Read more from David Fabian, Managing Partner at FMD Capital Management:
2014 ETF Income Investing Ideas: Part 1 – Bonds
2014 ETF Income Investing Ideas: Part 2 – Dividend Equities
2014 ETF Income Investing Ideas: Part 3 – Alternative Strategies
No positions in stocks mentioned.