Most small-cap exchange-traded funds are trailing the broader large- and mid-cap funds, as the current market cycle favors large-cap investments.
The softer returns of most small-cap ETFs reflect the underperformance of the benchmark Russell 2000, which is up 2.75 percent year-to-date. Looking at the top 10 small-cap ETFs by assets under management, most funds are showing year-to-date returns in the low single-digits or are even underwater.
Doug Ramsey, chief investment officer of The Leuthold Group, says while real short-term interest rates are negative, which usually favors small caps, the current market cycle favors large caps.
“The extreme maturity of the cyclical bull market favor large over small, with the vast majority of cyclical bulls exhibiting a late-cycle ‘distribution’ phase, in which small caps and mid caps—and even the ‘average’ S&P 500 stock—underperform the S&P 500 and DJIA,” he says.
The Federal Reserve has also been raising interest rates, which as hurt dividend-paying funds. That could explain the weakness behind the worst-performing small-cap ETF in the top 10, the WisdomTree U.S. SmallCap Dividend Fund (DES). The company says the fund can be used “to satisfy demand for growth potential and income focus.” Perhaps, but It’s down 3.9 percent this year.
Its weakness might be explained by some of its holdings. Two of the top three stocks are energy companies—Pattern Energy Group Inc. and CVR Energy Inc., and energy remain weak. Its three top sectors are consumer discretionary at 19 percent, industrials at 18.44 percent and real estate at 15 percent. It has an expense ratio of 38 basis points and $1.8 billion in AUM, with a 3.53 percent yield.
The best-performing small-cap ETF in the top 10 isn’t a U.S. ETF, but a European-centric fund, the WisdomTree Europe SmallCap Dividend Fund (DFE), which is up 23.50 percent year-to-date.
The fund reflects some of the broader gains seen in Europe’s improving economy.
Josh Feinman, chief global economist at Deutsche Asset Management, says there’s been solid economic momentum in Germany, better conditions in France and improvements in some of the peripheral economies such as Spain and Ireland.
“Accommodative monetary policy, less fiscal austerity, and the lagged effects of the euro’s depreciation have all helped, creating positive feedbacks through healing labor markets and brightening sentiment," he says. "Political risks have diminished too, as populist, anti-European Union parties were defeated in the Netherlands and France, reducing existential risk to the European integration project and even opening the door for much-needed reform."