After lagging the performance of large-cap stocks last year, the major small-cap indexes surged ahead of the S&P 500 and other large-cap benchmarks during the first months of 2015. One reason, say analysts, is the earnings disappointments among export-heavy large caps hurt by the dollar’s strong run.

With the dollar up 25% or more against the euro and other currencies over the past year, large U.S. companies that do a lot of business overseas have seen earnings decline as it becomes difficult to price exports competitively and as sales in weaker currencies translate into fewer dollars back home. The currency headwind is a major reason many S&P 500 companies, which derive about 40% of sales from overseas, reported a year-over-year drop in first-quarter earnings.

Smaller companies don’t face currency or geopolitical issues to the same extent, since they conduct most of their business in the U.S. And it’s often possible to find smaller companies that do pretty much the same thing larger ones do with little or no international exposure. A stronger dollar adds to the other classic advantages of small caps: their better long-term returns and their potential for earnings growth that’s faster than what large caps enjoy.

On the other hand, small-cap stocks can lag large caps for long periods, especially when market uncertainty draws investors to more predictable blue chips. The stocks of smaller companies are typically more volatile than those of larger ones, and their earnings are less predictable. After several years of mostly strong performance, small caps are selling at a slightly higher price-earnings multiple than large caps right now, which means they are no bargain.

Nonetheless, the recent rebound for the asset class is a good reason to review the diverse members of this 59-member ETF universe, where even small differences in index composition can make a dent in performance. For example, two different Vanguard ETFs, one following the Russell 2000 and the other the S&P SmallCap 600 index, were up 15.53% and 13.75%, respectively, over the year ending April 15. Over five and 10-year periods, however, the latter index outperformed. Growth versus value is another issue worth examining, since the performance and valuation gap between the two has been particularly wide over the last year.

Broad-Based
For most ETF investors, the route to investing in the small-cap universe is through a broad-based ETF that blends growth and value stocks. At over $30 billion in assets, the iShares Russell 2000 fund (IWM, which has an expense ratio of 0.20%) is the largest ETF in the category and is nearly twice as large as its nearest competitor. With millions of shares traded each day, it is highly liquid and does a good job of tracking the approximately 2,000 small and micro-cap stocks it covers. It has a weighted average market cap of $2.1 billion. Two smaller ETFs also track the Russell 2000: the Vanguard Russell 2000 fund (VTWO, which has an expense ratio of 0.15%) and the SPDR Russell 2000 fund (TWOK, whose expense ratio is 0.12%).

While the Russell 2000 is considered the marquee index for small-cap stocks, Morningstar analyst Michael Rawson argues that its popularity makes the ETFs that follow it vulnerable to “front-running” by arbitrageurs. “When these arbitragers trade ahead of the index, they can hurt the index’s performance by pushing up the prices of the stocks that it is set to add and by depressing the prices of the stocks that it is slated to trim,” Rawson wrote in a recent report. “Investors may be better served in an index fund that tracks a less popular small-cap index, such as the S&P SmallCap 600 index or CRSP U.S. Small Cap Index.”

Several ETFs are available for investors who share that concern. At over $16 billion in assets, the iShares Core S&P Small Cap fund (IJR, whose expense ratio is 0.12%) is the second-largest ETF in the small-cap group. It tracks the S&P SmallCap 600 index, which covers about 4% of the total U.S. stock market. It has an average market cap of $1.77 billion and a slightly lower standard deviation than the Russell 2000. Two other ETFs, the S&P Small Cap 600 fund (SLY, which has an expense ratio of 0.15%) and the Vanguard S&P Small Cap 600 fund (VIOO, which has an expense ratio of 0.15%) track the same index but are smaller and have wider trading spreads.

First « 1 2 » Next