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Time to Buy Small Cap ETFs

After lagging in the first five months of 2017, small cap stocks have regained their sheen and are currently outperforming the broader U.S. market. This is especially true as the ultra-popular small-cap ETF IWM has gained 2.9% over the past 10 days compared with the addition of 0.7% for the large-cap cousin SPY and 1.6% for the mid-cap counterpart IJH.

The outperformance has come on the back of overvaluation concerns and re-emergence of geopolitics in recent weeks. In fact, the five biggest technology stocks, which were the main drivers of the stock rally this year, lost more than $97.5 billion in market value on Friday on a report from the leading investment bank – Goldman Sachs. The bank has warned that the stock price of these tech companies have seen a rapid rise, making investors’ jittery (read: Tech Face Off: Amazon Versus Alphabet ETFs).

Additionally, last week’s UK election resulted in a hung parliament and triggered a bout of political uncertainty in Europe. This is because British Prime Minister Theresa May's Conservative Party lost their majority in the parliament. This could leave the Brexit process, slated to start on June 19, in disarray. The deepening political turmoil could boost the dollar in the near term (read: What Does UK Hung Parliament Mean for Europe ETFs?).

Further, growing tension in the Gulf States after Saudi Arabia, Bahrain, Egypt and the United Arab Emirates broke their diplomatic ties with Qatar added to investors’ woes.

Against such a backdrop, small cap stocks are the biggest beneficiaries as these are closely tied to the U.S. economy and do not have much exposure to the international market. These pint-sized stocks generate most of their revenues from the domestic market, which is showing remarkable growth buoyed by an impressive labor market, increase in wages, rise in inflation and increasing consumer spending.

Small caps look to outperform, as these are free from the clutches of any political malaise or a strong greenback and ensure higher returns on improving economic health. Since these companies are small, they are poised to grow more than their already tapped out large-cap counterparts.

The Fed is likely to lift-off rates in its June meeting this week, indicating a stronger economy and in turn propel small-cap stocks higher. The dovish tone on the future pace of rate hike is also positive for these stocks, which may be hit hard when borrowing costs increase (read: Time to Buy Global Low Volatility ETFs?).

Given improving near-term trends, investors could consider building positions in small-cap ETFs. Below we have presented five small cap ETFs that have crushed IWM over the past 10 days and have a Zacks ETF Rank of 3 (Hold), suggesting room for more upside. These could be excellent plays to ride out domestic economic growth while avoiding foreign political risk.

Guggenheim S&P SmallCap 600 Pure Growth ETF RZG

This fund offers exposure to the growth segment of the small-cap market. It tracks the S&P SmallCap 600 Pure Growth Index, charging investors 35 bps in annual fees. Holding 150 securities in its basket, it is well spread out across components with each holding less than 1.8% share. Health care and information technology take the top two spots with over 20% share each while industrials, consumer discretionary, and financials round off the top five with double-digit allocation each. The fund has amassed $183.7 million in its asset base while trades in light volume of about 9,000 shares a day on average. The product has gained 3.9% over the past 10 days (read: Small Cap ETFs: Leaders or Laggards).

WisdomTree SmallCap Earnings ETF EES

This fund targets earnings-generating small-cap companies by tracking the WisdomTree SmallCap Earnings Index. Holdings 793 stocks in its basket, the ETF provides a nice balance across various securities as each firm holds less than 2.2% share in the basket. Consumer discretionary and financials are the top two sectors with at least 21% share each. The product has AUM of $482.9 million in its asset base and sees moderate volume of around 58,000 shares per day. It charges 38 bps in annual fees and has added 3.6% in the same time frame.

Vanguard Russell 2000 Value ETF VTWV

This fund targets the value segment of the U.S. small cap market by tracking the Russell 2000 Value Index. It provides well-diversified exposure to a broad basket of 1364 stocks as none of these holds more than 0.5% of assets. About 42.4% of the portfolio is allotted to financial services while producer durables and consumer discretionary also takes double-digit exposure each. The product has accumulated $164.8 million in its asset base while volume is light at 14,000 shares a day on average. It charges 20 bps in annual fees and was up 3.5% in the same time frame.

iShares Russell 2000 Value ETF IWN

This is one of the popular and liquid ETFs in the small cap space with AUM of $8.4 billion and average trading volume of 1.2 million shares a day. The fund provides exposure to a broad basket of 1342 stocks that are thought to be undervalued relative to comparable companies. It follows the Russell 2000 Value Index and is well spread out across components as none of these holds more than 0.60% of assets. Sector wise, financials takes the top spot with 32.2% share, followed by a double-digit allocation each in industrials, information technology, and real estate. The fund charges 25 bps in annual fees and has gained over 3.5% in the same time frame (see: all the Small Cap ETFs here).

First Trust Small Cap Value AlphaDEX Fund FYT

This fund also provide exposure to small-cap value stocks by tracking the NASDAQ AlphaDEX Small Cap Value Index. It has 262 stocks in its basket using the AlphaDEX methodology with none holding more than 0.84% of assets. Consumer discretionary, industrials, and financials are the top three sectors accounting for double-digit exposure each. FYT has a lower level of AUM at $63.7 million and charges 70 bps in fees per year. Volume is light, exchanging about 41,000 shares a day on average. It was up 3.4% over the past 10 days.

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SPDR-SP 500 TR (SPY): ETF Research Reports
ISHARS-R 2000 (IWM): ETF Research Reports
WISDMTR-SC ERN (EES): ETF Research Reports
GUGG-SP 600 PG (RZG): ETF Research Reports
FT-SC VALUE AD (FYT): ETF Research Reports
ISHARS-RS 2K VL (IWN): ETF Research Reports
ISHARS-SP MID (IJH): ETF Research Reports
VANGD-RUS 2000V (VTWV): ETF Research Reports
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Zacks Investment Research
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