In the equities market, stocks of varying market capitalization come with different levels of risk and rewards. So far this year, riskier micro-capitalization weighted exchange traded funds have been outpacing all other asset categories.
Micro-cap companies have a market capitalization of around $50 million and $300 million, or less than small-cap stocks. Typically, investors will notice that larger capitalization stocks are less risky, generating smaller but more steady returns. In comparison, smaller company stock see greater swings, but the added risk comes with potentially greater returns.
“By size, micro-caps make up less than 2% of total market capitalization,” according to Morningstar analyst Michael Rawson. “From 1926 to 2012 they’ve earned about 3% annualized over large caps, a return bonus traditionally called the size premium. Investors expect excess return from them because micro-cap stocks are often speculative and trade with much greater volatility than large caps.”
So far this year, the size premium seems to be holding up. For instance, the largest micro-cap-related ETF, the iShares Micro-Cap ETF (IWC) , which has over $1 billion in assets, has gained 6.2% year-to-date and is up 37.2% over the past year, outperforming other asset categories.
In contrast, the S&P 500 Index has gained 1.8% year-to-date and rose 22.7% over the last year. The S&P MidCap 400 Index returned 2.9% so far this year and increased 20.6% over the past year. Meanwhile, the S&P SmallCap 600 Index is up 2.2% year-to-date and 27.9% over the last year while the broader Russell 2000 Index of small-cap stocks is 3.3% higher this year and 27.6% higher over the past year.
While IWC has produced some attractive returns, potential investors should be aware that liquidity issues in the underlying micro-cap stocks can drag on performance of the overall fund as the underlying index’s buy and sell orders can move prices against the fund, Rawson added.
IWC tracks 1,344 micro-cap stocks and has a 0.72% expense ratio. Top sectors weights include financial 26.4%, health care 19.8% and tech 13.9%.
PZI tracks a smaller portfolio of 400 micro-cap stocks. The underlying index identifies micro-caps with the greatest potential to outperform passive benchmarks and other actively managed strategies. The enhanced indexing methodology makes the ETF come with a slightly higher 0.93% expense ratio. Top sector allocations include financials 28.7%, industrials 15.8% and consumer discretionary 14.9%. The fund has gained 3.6% year-to-date and is up 31.2% over the past year.
WMCR tracks the Wilshire US Micro-Cap Index, which currently holds around 966 stocks ranked below 2500 by market capitalization from the Wilshire 5000 index. Top sectors include financials 28.6%, health care 20.4% and information technology 13.7%. The Guggenheim ETF is the cheapest of the three, with a 0.53% expense ratio. WMCR has gained 8.2% year-to-date and is up 40.5% over the past year.
For more information on micro capitalization funds, visit our micro-cap category.
Max Chen contributed to this article.
Full disclosure: Tom Lydon’s clients own shares of IWC.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Mr. Lydon serves as an independent trustee of certain mutual funds and ETFs that are managed by Guggenheim Investments; however, any opinions or forecasts expressed herein are solely those of Mr. Lydon and not those of Guggenheim Funds, Guggenheim Investments, Guggenheim Specialized Products, LLC or any of their affiliates. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.
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