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ETF Chart of the Day: U.S. Small Cap Funds

tlydon@globaltrend.com (Tom Lydon)

In keeping pace with the two ETF pieces that we penned on Tuesday and Wednesday earlier this week, where we concluded that dividend weighted approaches in both the U.S. large and mid-cap equity core equity space delivered superior returns to other approaches in 2011, today we examine the small cap category.

Most investment managers and observers will agree that the small cap space is ripe with fundamental inefficiencies, which creates larger amounts of volatility and risk, but also opportunity for outperformance for adeptly managed strategies.

Many small cap companies have little in the way of analyst coverage and much lower market capitalizations and trading volumes than mid or large cap names, and thus, it makes logical sense that one with an “information edge” in any given sector or name in small cap, would have a pronounced advantage over others.

Interestingly, despite the outperformance last year of dividend weighted strategies in both large and mid caps in 2011, DES (WisdomTree Small Cap Dividend) fell well short of the market cap weighted index benchmark, IJR (iShares Small Cap 600), and lost 5.32% versus IJR’s basically flat performance of -0.28% on the year. In fact, IJR was the best performer in this small cap “core” group as we will see shortly.

FYX (First Trust Small Cap Core AlphaDEX) , a fundamentally/quantitative weighted approach, fared reasonably well last year too, down only 0.56%. RWJ (RevenueShares Small Cap), which is the revenue weighted version of the S&P 600 Small Cap index, lost 1.29%, while EES (WisdomTree Small Cap Earnings) fell 3.16%. Other market cap weighted index ETFs fell well short of IJR last year, as IWM (iShares Russell 2000) fell 5.82%, VB (Vanguard SmallCap) lost 4.08%, and SCHA (Schwab U.S. Small Cap) was down 4.25%.

Two other fundamentally/quantitative weighted funds, PRFZ (PowerShares FTSE/RAFI U.S. 1500 Small-Mid) , which most classify as a small cap/mid cap or “SMID” hybrid fund, fell well short of the market cap benchmark, and was down 6.92%. PXSV (PowerShares Fundamental Pure Small Value) was down 4.29% in 2011.

Noting the dispersion in the returns across the various products that we have highlighted in this space, it does seem clear that different weighting methodologies and approaches may perform better or worse depending on the specific market environment, and given the nature of small cap investing as we had mentioned earlier, it makes sense to consider multiple ETF strategies here for an overall approach. Market cap, in IJR, trumped other approaches last year notably in the small cap space, and it remains to be seen what 2012 will bring us in terms of a winning methodology.

iShares Russell 2000

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