Paulsen also likes the consumer cyclicals and industrials. Some ETFs that reflect those sectors include the iShares S&P SmallCap 600 Growth ETF (IJT), which has 18.4 percent of its fund in industrials and 15.97 percent in consumer cyclicals. It has an expense ratio of 25 basis points and $5 billion in assets under management.
The Vanguard Small-Cap ETF (VB) is another broad-based ETF with a sizable allocation to industrials and consumer cyclicals—16.5 percent in industrials and 13.3 percent in consumer cyclicals. It has $22 billion in AUM and an expense ratio of 6 basis points.
Investors seeking a more narrowly focused ETF can choose the PowerShares S&P SmallCap Industrials Portfolio (PSCI). Its expense ratio is 29 basis points, but it significantly trails IJT and VB in terms of size at $110 million in AUM.
Growth Vs. Value?
Paulsen says the positive economic outlook favors small caps. With labor statistics showing the U.S. is close to full employment, gross domestic product growth rates forecast to be around three percent and a synchronized global economic recovery, it all might help to reignite a small amount of inflation, which is good for small caps. Slightly higher inflation helps top-line growth, which is particularly important for small caps, Paulsen adds.
That said, small-cap investors need to be wary of tightening liquidity, Paulsen says. He noted that credit conditions have tightened over the past three quarters, and that’s a bigger issue for small-cap companies since they don’t have access to credit the way large caps do. If the Federal Reserve raises rates as forecast this year, that could further tighten credit.
However, Bruno from IndexIQ says that might be less of an issue for small caps now because a lower corporate tax rate may free up cash, making it easier for small caps to self-finance.
When looking at how to add small-cap ETFs to a portfolio, broad-based indexes may be better than the narrowly focused ones since it’s too early to tell which areas will benefit in 2018, Bruno says. Additionally, Paulsen and Bruno say it’s too hard to call whether to lean toward a growth or value tilt in a portfolio. Given valuations for all equities are high, Bruno says investors should focus on high-quality companies instead.
“Looking at it holistically, it’s a tough call to make when [investors should] tilt to growth or value," Bruno says. "Blend them to get a balance.”