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An Exciting View for Small Cap ETF Investors

This article was originally published on ETFTrends.com.

Small-cap stocks and the corresponding ETFs are delivering for investors. That includes some smart beta strategies, such as the WisdomTree SmallCap Earnings Fund (EES) .

EESEES, which weights its components by earnings, is up nearly 20% this year. The fund is one of several earnings-weighted products from WisdomTree, which also offers the WisdomTree Total Earnings Fund ETF (EXT) and WisdomTree Earnings 500 Fund (EPS) , among others.

Small-capitalization stocks have attracted a lot of attention on the escalating trade tensions, fueled by fears over a potential slowdown in global growth. Consequently, many anticipated that small-caps could weather the storm as large multi-nationals with a large global footprint suffered from trade disputes.

EES's underlying index the, WisdomTree U.S. Earnings Index, “only includes companies with proven profitability, weighted by the earnings that they’ve generated. Valuation risk is also mitigated here, but the approach is broader and more core-oriented, capturing growth companies that may not pay dividends but that do have positive profits,” said WisdomTree in a recent note.

What's Next for Indexing Methodology

Due to this particular indexing methodology, the ETFs lean toward value and quality factors, and within the mid- and small-cap ETFs, the size factor, which have all been historically associated with excess returns compared to the broader market over the long-haul.

EES can be alternative to traditional, diversified small-cap ETFs, which may track benchmarks chock full of richly valued growth stocks from the healthcare and technology sectors.

Historic data have shown that smaller companies typically outperformed larger companies over time as more nimble, smaller businesses have more room to quickly expand. Additionally, many argued that there are inefficiencies in the market as investors mispriced the value factor, which leaves these types of companies open to outperform over the long-term.

“At the end of 2018, the WisdomTree U.S. Earnings Index indicated a forward P/E ratio that was more than 54% less expensive than the Russell 2000 Index,” according to WisdomTree. “The WisdomTree U.S. Earnings Index has been in live calculation since February 1, 2007, and has never ended a year with a discount like it has now. This tells us that, if there are to be late-cycle rallies and a bit of multiple expansion in U.S. small caps, this strategy may have the potential to capitalize.”

For more information on alternative index-based strategies, visit our smart beta category.

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