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Small-Cap ETFs

tlydon@globaltrend.com (Tom Lydon)

Traditional open-end mutual funds do not have the best track record when it comes to market-capitalization oriented options, with the majority of active managers underperforming indices. However, exchange traded funds passively track underlying benchmarks and provide a straight forward investment strategy.

An industry report from late 2011 calculated that about two-thirds of large-cap mutual funds underperformed their equivalent benchmarks over the last three years, writes Ryan C. Fuhrmann for Investopedia. Small-caps were the best category, but 63% of managers still underperformed. [Are Small-Caps a Better Emerging Market ETF Option?]

Given the high rate of underperformers, investors may be better off using market-capitalization ETFs. ETFs try to passively reflect the performance of a benchmark index – if the index increase by a certain percentage, the ETF will closely mirror the same percent gain. [ETFs vs. Index Funds]

Fuhrmann also notes that the high expense ratios may also attribute to the mutual funds’ underperformance, especially in small-cap funds where expenses tend to run higher. For instance, the majority of mutual funds have expense ratios above 1%, with some as high as 1.65%. In comparison, the average ETF industry expense ratio is about 0.55%.

Broad Index-based ETFs usually fall on the low end of the expense ratio spectrum. Examples include:

  • iShares S&P 500 Index (IVV - News) : 0.09% expense ratio
  • iShares Russell 2000 Index (IWM - News) : 0.26% expense ratio
  • iShares S&P SmallCap 600 (IJR - News) : 0.20% expense ratio
  • Vanguard SmallCap ETF (VB - News) : 0.16% expense ratio

For more information on small-capitalization funds, visit our small-cap ETFs category.

Max Chen contributed to this article.