Small cap stocks have had a rough ride this year. iShares Russell 1000 ETF (IWM)—which tracks the performance of small cap US equities--is down about 5 % in 2014, after a spectacular performance last year when it gained about 38%. On the other hand, iShares Russell Top 200 ETF (IWL) has gained more than 7% this year, even after the market sell-off seen this week.
And it’s not just the small caps that have been out of favor of late. In general, investors have been avoiding other riskier assets too, including junk bonds, emerging markets and commodities. Concerns over economic slowdown in Europe and China and rising geopolitical risks have led investors to seek refuge in “safer” assets. (Read: Healthcare ETFs for your portfolio’s wellness)
Monetary policy uncertainty has been adding to investors’ worries. The Fed is all set to end its bond buying program this month and start raising rates sometime next year. But it remains to be seen how the market will respond to the unwinding of extraordinary monetary easing measures that have been in place for more than six years.
Some of these small companies do look quite attractive compared to their growth prospects, after the recent sell-off, but it is uncertain whether investors will embrace them again. Many investors believe that valuations of smaller-cap stocks still appear stretched after the huge run-up seen in the past few years.
It is true that the US economy has been improving but a lot of that optimism has probably been already priced in by the market. Also, market volatility has started rising and small-caps tend to underperform in high volatility environment. (Read: 3 Best New ETFs of the Third Quarter)
Further, per iShares research , while smaller companies perform better during an accommodative monetary period, large- and mega-cap companies outperform in the higher real interest rate environment. Smaller companies in general find financing a bit difficult in the rising rate environment.
Most of large companies have huge cash piles on their balance-sheets and are likely to return more cash to shareholders via dividends and buybacks, going forward. (Another reason for investing in larger companies now is that many investors who have either continued to invest in bonds or stayed on the sidelines will begin to embrace stocks when they finally realize that the bull market in bonds is over. Being very risk averse, these investors tend to favor larger, stable, well-known companies over smaller riskier players. (Read: Best ETF Strategies for the Fourth Quarter)
It may be thus be the right time to invest in some of the largest and the best known companies that not only look attractive on valuation basis but are also poised to outperform in the longer-term.
Below we have analyzed three ETFs that invest in very large capitalization, stable companies that generate solid cash flows and add stability to the portfolios. Most of these companies have sustainable competitive advantages and fortress-like balance sheets, which ensure long-term success.
iShares S&P 100 ETF (OEF)
OEF is the largest fund in the space with over $4.8 billion in assets. It tracks the S&P 100 index, and holds 100 largest US companies. Top holdings include Apple, Exxon Mobil, GE, Microsoft and J&J. In terms of sector exposure, Information Technology, Financials and Healthcare take the top three spots. The product charges an expense ratio of 0.15% and has a dividend yield of 1.92% currently.
Vanguard Mega Cap ETF (MGC)
MGC follows the CRSP US Mega Cap Index, which is comprised of largest U.S. stocks representing approximately the top 70% of market capitalization. It has an AUM of $1.1 billion, invested in 304 holdings.
The fund is pretty diversified in various sectors, with biggest allocations to Financials, Technology, Consumer Services and Healthcare. Top holdings are pretty similar to OEF, with Apple, Exxon Mobil, Microsoft and Google in the first four spots.
The product has a very low expense ratio of 11 basis points and it pays dividends at 1.85% currently.
iShares Russell Top 200 ETF (IWL)
IWL tracks the Russell Top 200 Index measures the performance of the largest cap segment of the U.S. equity universe. Technology, Financials and Healthcare are the top sectors the fund has exposure to. Top holdings are Apple, Exxon Mobil, GE, 1.92% currently.
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