Small-Cap Value ETFs Show Again Why They Are Darlings Of The Market

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Small value stocks can often trip up investors. It takes skill to unearth the gems that can be bought cheap and sold eventually for a fat profit. Hoped-for darlings can turn to duds. But in a diversified ETF wrapper, it's a very different story.

Small-cap value ETFs shone through the political and market tumult of November as they kept up their hot pace of 2016. They have also turned in attractive returns over the long haul.

IShares S&P Small-Cap 600 Value ( IJS ) jumped 13.3% in November to take its year-to-date gains to roughly 27%.

By comparison, the large-cap iShares Core S&P 500 ( IVV ) gained around 4% and 9.4% over those respective periods. And it lags IJS in performance over the past five, 10 and 15 years.

The sting in the tail with small value is higher volatility and bouts of underperformance - as 2015 unpleasantly reminded investors.

Why have investors gravitated toward small companies this year?

"In part, U.S. small caps may have benefited from the relatively strong U.S. economy," analysts at FTSE Russell wrote in a report titled "Small Cap Perspectives" and released in September. They proceeded to describe the United States as "the least dirty shirt" for investors looking at all the economies around the globe for the best growth prospects.

"That can disproportionately boost small caps because these companies tend to generate the majority of their revenue from domestic business," they added. "Large caps tend to have more multinational revenue, tied to the health of overseas economies. We have also seen the dollar strengthen, especially since Brexit, which negatively impacts the export business of any U.S. company, but those with the most export dependence tend to skew toward larger cap."

The postelection scenario, with a bright outlook for strong equity markets with rising rates , has contributed to small-cap ETFs' most recent rally.

Here's a look inside November's three best-performing U.S. diversified equity ETFs, all holding hold small-cap stocks and value stocks.

  • IShares S&P Small-Cap 600 Value ( IJS ) invests $4.44 billion in assets across 456 stocks.

Top stock holdings include chemical maker Chemours ( CC ), Wintrust Financial ( WTFC ) and UMBFinancial ( UMBF ).

IJS has hefty stakes in economically sensitive sectors such as industrials, financial services and technology, which are seen to benefit as President-elect Donald Trump takes office.

The fund has a 0.25% expense ratio.

The underlying index weeds out companies in serious financial trouble, notes Morningstar analyst Alex Bryan. But it has considerable holdings overlap with its growth counterpart, tracked by iShares S&P Small-Cap Growth (IJT).

S&P uses three metrics - price-to-book, price-to-sales and price-to-earnings - to determine value. The index is rebalanced annually in December.

  • SPDR S&P Small-Cap 600 Value (SLYV) tracks the same index as IJS for a more palatable 0.15% expense ratio.

It is a smaller fund, with $734.3 million in assets. It has seen $182.8 million in net inflow in 2016 through November vs. $321.2 million for its iShares rival.

The performances of the two funds are virtually identical over both the short and long terms.

  • IShares Russell 2000 Value (IWN) leads this pack in size with assets of $8.07 billion.

It has a similar skew toward cyclical and economically sensitive sectors, but almost double the allocation to financials, at a 30% weighting.

Its 1,350 stock holdings make it a far more diversified ETF.

Top stocks include Webster Financial (WBS), Prosperity BancShares (PB) and fracking company RSP Permian (RSPP).

The underlying index of this ETF shows holdings overlap with its growth counterpart too, according to Bryan.

IJS charged 13.2% higher in November and is up 26.8% year to date. Investors poured $743.1 million into the ETF in November.

For the strongest exposure to small-cap value stocks, or the cheapest, investors have to look elsewhere.

Guggenheim S&P SmallCap 600 Pure Value (RZV) is a more aggressive play on this equity style. It distills the S&P Small Cap 600 index to 149 stocks for a relatively high 0.35% expense ratio.

Vanguard Small-Cap Value (VBR) is the largest ETF in this group at $9.32 billion in assets. It comes with the lowest expense ratio - 0.08%.

It rose on the stock market today and set a record high of 119.35 on Nov. 28.


How To Play Small-Cap ETFs In Strong Equity Markets With Rising Rates

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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