Small Cap ETFs to Consider
By Max Isaacman Oct 02, 2012 9:50 am
The last 10 years have been great -- if you were in small caps and some other asset classes.
Small Cap ETFs to Consider
Cap-Weighted. The S&P Small-Cap 600 ETF (NYSEARCA:IJR) is the major cap-weighted offering from iShares. There are advantages and disadvantages of cap-weighted ETFs, just as there are tradeoffs in other cap-weighting methods. With cap-weighted you do get the most exposure to the most dominant companies in that asset class, and sometimes this weighting performs the best and sometimes it doesn't. Cap-weighted indexes are simple, and one of the advantages of it is that the index only makes trades when the index makes changes to its underlying securities, which is not very often. This cuts down on the trading expenses of the ETFs that replicate the index.
Revenue-Weighted. The RevenueShares Small Cap ETF (NYSEARCA:RWJ) is weighted by stocks according to the highest top line revenue generated. These weightings are based on the same stocks that are found in IJR. VTL Associates, the ETF maker, says its studies show that revenue weighted indexes will produce higher returns than cap-weighted indexes over time, and also have a slightly lower beta. One of the reasons VTL uses revenues is because all companies have revenues, and not all companies have other fundamental factors such as net revenues, or dividends, or significant book value. VTL thinks that by using revenue weighting every stock in the S&P Small-Cap Index will be represented fairly, which maintains the breadth of that index. VTL believes that revenue weighted indexing can prevent an investor from being over-weighted in over-priced stocks, because the price of the stocks in the index does not determine the weight that the stocks will have in the index.
Earnings Weighted. The WisdomTree Small-Cap Earnings ETF (NYSEARCA:EES) is weighted by measuring the performance of companies that are generating earnings, and are selected from the small-cap segment of the US stock market. The index selects the companies in the bottom 25% of the market capitalization of the WisdomTree Earnings Index. Companies in the index have to be incorporated in the US and listed on US exchanges, and have generated positive cumulative earnings over their most recent four fiscal quarters prior to the latest index measurement date.
Foreign Small Cap Exposure. Most foreign ETFs are dominated by large, multi-national companies that domicile in foreign countries. Small cap stocks, more than big cap stocks, reflect the domestic economy of the countries that they are domiciled in. For instance, Russian small cap stocks will reflect better than big cap stocks the Russian economy and its components therein, and will include sectors such as the consumer discretionary sector, and the consumer cyclical sector.
So far, the small-cap growth ETFs in foreign countries have not performed as well as the bigger cap ETFs. For instance, iShares Inc (NYSEARCA:EEMS) has underperformed iShares MSCI Emerging Markets Indx (ETF) (NYSEARCA:EEM), and Market Vectors ETF Trust (NYSEARCA:RSXJ) has underperformed Market Vector Russia ETF Trust (NYSEARCA:RSX). This is probably due to the financial problems in Europe and other foreign countries. But at some point the risk environment should improve and there will be better performances in the small-cap foreign asset class.
Foreign stocks generally pay more dividend than US stocks. An ETF to consider for a longer-term value and dividend investment is the WisdomTree Emerging Markets Small-Cap ETF (NYSEARCA:DGS). The new China Dividend Ex-Financial ETF (NYSEARCA:CHXF) from WisdomTree looks interesting for a long term emerging markets investment. About 40% of the ETF is in small- and mid-caps.
My clients and/or I am long DEM, DGS, EEM, IJR, RWJ