Small cap indexes represent 8-16% of the total US stock
market. But many investors have no small cap exposure at all.
They own strictly large companies. Thoughtful investors will
equal-weight or even overweight small cap ETFs because
historically small caps outperform their large cap brethren.
The chart below compares the small cap ETF iShares Russell
2000 Index (NYSEArca:IWM) with the large cap SPDR S&P 500
The performance of the two ETFs in chart above is similar. Yet
the funds shown here have effectively no overlapping holdings.
IWM tracks the Russell 2000. The weighted average market cap of
the Russell is about 1.5 billion. It median market cap is 0.6
billion. The S&P 500 has an average weighted market cap of
about 24 billion. Its median market cap is 11.3 billion.
The chart above goes back just five years. Longer-term, small
cap has performed better. In a study that tracks a 50-year period
from 1956-2005 Fama and French concluded that small caps
outperform large caps by 4% annually.
There are many reasons for a long-term outperformance of small
cap. Smaller companies tend to be more nimble. They adapt quickly
to market conditions. They are less hamstrung by bureaucracy than
larger companies. And small companies are often acquired,
boosting their price.
But there are risks in investing in small cap. Small cap ETFs
hold less established companies. They tend to be more volatile
than large cap ETFs. In times of market stress small cap
companies typically underperform. They are more quickly sold.
What kind of underperformance can investors in small cap
expect in weak markets? The iShares Russell 2000 Index
(NYSEArca:IWM) has a beta of 1.20. Benchmark large cap ETFs that
track the S&P 500 Index such as the SPDR S&P 500
(SPY:NYSEArca) have a beta of 1.00. If the SPY falls 1 point,
expect IWM to fall 1.2 points. Of course, the same on the way up:
for every 1 point the SPY goes up, expect IWM to go up 1.2
points. In strong markets small cap ETFs will usually outperform
large cap funds.
Although they mostly perform similarly, small cap ETFs are not
all alike. Small cap companies lie within the 750 to 2000 US
stocks ranked by size. But some small cap ETFs hold relatively
smaller companies within this range. Some hold relatively larger
companies in this range.
Investors seeking exclusively small companies will want to
For more broad offerings investors should consider Vanguard's
Small-Cap ETF (NYSEArca:VB) and SPDR Dow Jones Wilshire Small Cap
ETF (NYSEArca:DSC). These ETFs include mid-cap companies at one
end, micro-cap at the other.
iShares S&P 600 Small Cap Index (NYSEArca:IJR) targets a
tight band of larger-than-average small firms. It is one of the
most popular small cap ETFs by volume.
Fees for the basic small-cap ETFs range from about 0.10% per
year to about 0.25%. Although its net assets are smaller than
some of the other funds, VB is a good choice for an investor with
no specific index target in mind.
Like in other asset classes, even among very similar ETFs
there is sometimes deviation. The SPDR and Vanguard products for
example seem to use identical indexes. Both follow stocks ranked
751-2500. But the DJ Wilshire Small Cap Index and the MSCI US
Small Cap 1750 Index commonly deviate by 1% per year, or more.
Likely causes are specific filtering methodologies which result
in different industry sector weightings.
A prudent course when deciding between any set of similar ETFs
is to avoid those with high exposure to industries considered
overvalued. We hesitate to call any one index better for the
long-term just because it outperforms over specific periods.
Reversion to the mean will likely occur. Still, it remains
instructive to see how indexing methodology can cause two
seemingly identical ETFs to diverge at times.
A list of popular small cap ETFs follows:
Plain Vanilla Small Cap ETFs
iShares Russell 2000 Index (NYSEArca:IWM)
SPDR Dow Jones Wilshire Small Cap ETF (NYSEArca:DSC)
Vanguard Small Cap ETF (NYSEArca:VB)
Focused Small Cap ETFs
SPDR Dow Jones Wilshire Small Cap Growth ETF
SPDR Dow Jones Wilshire Small Cap Value ETF (NYSEArca:DSV)
Vanguard Small-Cap Growth ETF (NYSEArca:VBK)
Vanguard Small-Cap Value ETF (NYSEArca:VBR)
iShares Morningstar Small Growth ETF (NYSEArca:JKK)
iShares Morningstar Small Value ETF (NYSEArca:JKL)
iShares Morningstar Small Core ETF (NYSEArca:JKJ)
iShares Russell 2000 Growth ETF (NYSEArca:IWO)
iShares Russell 2000 Value ETF (NYSEArca:IWN)
iShares MSCI EAFE Small Cap Index Fund (NYSEArca:SCZ)
iShares S&P SmallCap 600 Growth Index Fund
iShares S&P SmallCap 600 Value Index Fund
Rydex S&P SmallCap 600 Pure Growth ETF (NYSEArca:RZG)
Rydex S&P SmallCap 600 Pure Value ETF (NYSEArca:RZV)
International Small Cap ETFs
SPDR Russell/Nomura Small Cap Japan ETF (NYSEArca:JSC)
SPDR S&P Emerging Markets Small Cap ETF (NYSEArca:EWX)
SPDR S&P International Small Cap ETF (NYSEArca:GWX)
WisdomTree International SmallCap Dividend Fund
WisdomTree Europe SmallCap Dividend Fund (NYSEArca:DFE)
WisdomTree Japan SmallCap Dividend Fund (NYSEArca:DFJ)
Sub-Sector Small Cap ETFs
PowerShares S&P SmallCap Financal (NasdaqGM:PSCF)
PowerShares S&P SmallCap Consumer Discretionary
PowerShares S&P SmallCap Consumer Stapl
PowerShares S&P SmallCap Energy (NasdaqGM:PSCE)
PowerShares S&P SmallCap Information Technology(NasdaqGM:
PowerShares S&P SmallCap Utilities (NasdaqGM:PSCU)
PowerShares S&P SmallCap Health(NasdaqGM:PSCH)
PowerShares S&P SmallCap Industrials (NasdaqGM:PSCI)
PowerShares S&P SmallCap Materials (NasdaqGM:PSCM)
Fundamental Small Cap ETFs
Powershares Dynamic Small Cap Value Portfolio ETF
Powershares FTSE RAFI US 1500 Small-Mid Portfolio ETF
First Trust Small Cap Core AlphaDEX Fund (NYSEArca:FYX)
FTSE RAFI Developed Markets ex-U.S. Small-Mid Portfolio ETF
PowerShares Dynamic Small Cap Growth ETF (NYSEArca:PWT)
PowerShares Dynamic Small Cap Portfolio ETF (NYSEArca:PJM)
RevenueShares Small Cap ETF (NYSEArca:RWJ)
Leveraged/Short Small Cap ETFs
ProShares Ultra Russell 2000 ETF (NYSEArca:UWM)
ProShares Ultra Russell 2000 Growth ETF (NYSEArca:UKK)
ProShares Ultra Russell 2000 Value ETF (NYSEArca:UVT)
ProShares UltraShort Russell 2000 ETF (NYSEArca:TWM)
ProShares UltraShort Russell 2000 Growth ETF
ProShares UltraShort Russell 2000 Value ETF (NYSEArca:SJH)
ProShares UltraShort SmallCap600 ETF (NYSEArca:SDD)
ProShares Short SmallCap 600 ETF (NYSEArca:SBB)
ProShares Ultra SmallCap 600 ETF (NYSEArca:SAA)
has been writing about ETFs since 2003 and is the author of
Sector Trading: A Year in Exchange Traded