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As Small-Caps Rebound, so Does a Familiar ETF

Small-cap stocks have endured significant scrutiny this year and rightfully so. Even with an impressive rally that has seen the iShares Russell 2000 ETF (IWM) jump nearly 10% off its Oct. 10 bottom, the largest small-cap ETF is still only up half a percent this year.

That compares to a nearly 9.5% gain for the S&P 500, but some investors have been more than nibbling at small-caps this month, waiting on the aforementioned rebound. Investors have added over $1.8 billion to IWM this month, indicating institutional money is being put to work in the ETF. [Investors Return to Small-Cap ETFs]

If the small-cap rally continues to legitimize itself another familiar face among ETFs tracking smaller stocks will be worth revisiting. Actually, it already has been. The PowerShares DWA SmallCap Momentum Portfolio (DWAS) is up 11.5% since Oct. 10.

DWAS rose to small-cap ETF acclaim last year when it surged 50.1% compared to a 38.7% gain for IWM. Stocks held by DWAS are selected specifically because of their robust relative strength traits, which has significant out-performance of broader small-cap indices last year. Investors flocked to DWAS last year, helping the ETF double in size. [These ETFs Doubled in Size]

However, when momentum and small-caps fell out of favor earlier this year, DWAS paid the price. From the start of March through the end of June, DWAS traded lower even as IWM eked out a modest gain.

A large part of DWAS recent out-performance of the Russell 2000 is attributable to the ETF’s overweight position in health care stocks. With small-cap health care names, that usually means biotechnology and life sciences firms. DWAS has a 23.3% weight to the health care sector, 920 basis points more than IWM allocates to the sector.

Conversely, DWAS only features a 14.4% weight to financial services stocks compared to 25.3% in IWM. That could prove advantageous for DWAS if interest rates remain low for a significant period because smaller financial services firms would like to see rates rise to have their net income margins boosted.

Speaking of rising rates, it should be noted that the smaller stocks and momentum factors have a history of delivering out-performance as rates rise. Additionally, DWAS allocates almost 45% of its weight to consumer discretionary, technology and industrial names, three of the better-performing sectors when rates rise. [A Small-Cap ETF for Rising Rates]

Investors have remained pensive, pulling $74 million from DWAS this month, but the ETF could defy skeptics if it can move above resistance at $38.

PowerShares DWA SmallCap Momentum Portfolio