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All Contents © 2019The Kiplinger Washington Editors
By Will Ashworth
| October 4, 2018
It has been 25 years since the launch of the SPDR S&P 500 ETF (SPY), America’s first exchange-traded fund. Since then, U.S. ETF assets have growth to more than $3.4 trillion across more than 5,000 funds. They’ve become the product of choice for individual and institutional investors alike.
However, of those several trillion dollars, only $174 billion, or roughly 5%, gets put into small-cap ETFs. That’s unfortunate, because the exchange-traded fund is the perfect way to capture the potential of small-cap stocks while reducing downside risk.
It doesn’t hurt that smaller companies have been performing financially well.
“Small-cap equities provide an opportunity for investors to invest in companies that generate a large portion of their revenue inside the U.S., potentially insulating them from geopolitical developments,” says Michael O’Keeffe, Stifel’s chief investment officer and global head of investment strategy. “We remain constructive on U.S. small-cap equities looking forward.”
Here’s a look at 10 small-cap ETFs that should be on your radar. If you want to build a well-constructed portfolio, it would be wise to consider a fund that invests in U.S. small-cap stocks, as well as one that holds foreign small caps.
Data is as of Oct. 3, 2018.
Type: Domestic small cap
Market value: $45.5 billion
Dividend yield: 1.2%
The iShares Core S&P Small Cap ETF (IJR, $85.77) is the second largest small-cap ETF in America, with $45.5 billion in assets. It’s also among the 15 largest ETFs in America regardless of style.
IJR tracks the performance of the S&P Small Cap Index – a collection of 600 companies with market capitalizations between $400 million and $1.8 billion at the time of investment. The 600 stocks represent just 3% of the entire U.S. cohort of publicly traded stocks.
The low cost of 0.07% is hard to ignore; it’s less than half the 0.19% charged by the largest small-cap ETF, the iShares Russell 2000 ETF (IWM). Also hard to miss is the five-year annualized total return of 14.55% over the past five years, as of June 30.
As its name suggests, IJR should be a “core” part of your portfolio.
Type: Foreign small-cap/mid-cap
Market value: $5.8 billion
Dividend yield: 2.8%
If you’re looking for a good ETF to complement your small-cap exposure in U.S. markets, the Vanguard FTSE All-World ex-US Small Cap ETF (VSS, $111.24) is an excellent way to go, and one recommended by Kiplinger in its Kip ETF 20.
VSS invests in roughly 3,600 small-cap stocks outside the U.S. as it tracks the performance of the FTSE Global Small Cap ex-US Index – and does so for a song at just 0.13% in annual expenses. Its top three geographic regions by weighting are developed Europe at 37.8%, developed Pacific at 28.8% and emerging markets at 19.7%.
VSS is not for someone interested in merely two or three good ideas; the top 10 holdings account for just 3% of the ETFs total assets. But if you like Canadian stocks, they accounted for six of the top 10 stocks as of the end of August — including Canopy Growth (CGC, $52.08), one of Canada’s biggest marijuana stocks.
Type: Domestic small-cap
Market value: $191.3 million
Dividend yield: 2.6%
Most investors try to avoid volatile stocks if they can help it. The SPDR SSGA US Small Cap Low Volatility Index ETF (SMLV, $95.65) is designed to do just that — a contrast to the typically volatile nature of small-cap stocks.
The SMLV tracks the SSGA US Small Cap Low Volatility Index, which takes 2,000 eligible U.S. stocks — the 1,001st largest by market cap through the 3,000th — and assigns each a sector. It then ranks every stock in a sector; the ones with the lowest volatility get the highest weighting. The volatility is determined by looking back at a stock’s monthly returns over a five-year period compared to its stock price over the same period.
The ETF holds roughly 400 stocks and boasts a very high turnover rate of 158%; all that trading does add a little bit of extra cost that isn’t reflected in the expense ratio.
Since its inception in February 2013, SMLV has averaged an annualized total return of 14.0%, as of Aug. 31, 2018, significantly outperforming its small-cap competitors.
Market value: $23.3 million
Dividend yield: 1.0%
The Invesco Russell 2000 Equal Weight ETF (EQWS, $46.77) is one of the fund provider’s five equal-weighted ETFs. The fund invests in Russell 2000 stocks, but instead of weighting them by market cap, it equally weights all the stocks every quarter — that means every stock has the same influence over the fund’s performance.
The ETF invests in stocks with an average market cap of $1.4 billion, and is a mash-up of under-the-radar stock such as top-10 holding Freshpet (FRPT), a pet-food company that focuses on natural ingredients.
Just note that this fund’s $23.3 million in assets is small compared to most of the funds on this list, and its lack of popularity also is reflected in low daily trading volume.
Type: Foreign small-cap/mid-cap
Market value: $2.3 billion
Dividend yield: 2.8%
One basis point cheaper than Vanguard’s small-cap, mid-cap option, The Schwab International Small-Cap Equity ETF (SCHC, $35.48) is slightly cheaper than Vangaurd’s small-/mid-cap option, and has delivered a five-year annualized total return of 5.38% — 39 basis points better than the VSS.
SCHC tracks the performance of the FTSE Developed Small Cap ex US Liquid Index, a group of 2,110 stocks that account for the bottom 10% of stocks in developed countries outside the U.S. with market caps of $150 million or more.
Japan, Canada and the U.K., the highest weightings at 19.8%, 16.2% and 15.2%, respectively.
A couple other differences between VSS and SCHC: Vanguard’s ETF has a big lead with $5.8 billion in assets, more than double SCHC’s $2.3 billion, and VSS invests in roughly 3,600 small-cap stocks — almost 70% more than Schwab’s more concentrated fund.
Type: Foreign small-cap emerging markets
Market value: $201.0 million
Dividend yield: 3.4%
The First Trust Emerging Markets Small Cap AlphaDEX Fund (FEMS, $35.48) tracks the performance of the Nasdaq AlphaDEX Emerging Markets Small Cap Index, an index that selects emerging-markets small-cap stocks that are generating positive risk-adjusted returns relative to traditional indexes.
The ETF charges 0.8% annually, which is very high compared to many of the ETFs mentioned on this list. The management expense ratio is high because of the AlphaDEX stock selection process, which uses both growth and value factors, to select the 200 stocks that ultimately make it into the index.
The ETF currently holds around 200 stocks with a median market cap of $1.2 billion. Geographically, the top three countries by weight are Taiwan, China, and Turkey with 22.8%, 18.0% and 8.3% respectively. Regarding sector makeup, materials, information technology, and real estate are the three biggest sector weightings at 18.4%, 15.7% and 15.1%, respectively.
Since its inception in February 2012, FEMS has generated an annualized total return of 6.2%, which is almost double the performance of the MSCI Emerging Markets Small Cap Index. That speaks volumes about the AlphaDEX stock selection process.
Type: Domestic small-cap value
Market value: $2.2 billion
Dividend yield: 3.0%
The WisdomTree U.S. SmallCap Dividend Fund (DES, $29.26) proves you can have your cake and eat it too.
This small-cap dividend ETF tracks the WisdomTree U.S. SmallCap Dividend Index, a group of dividend-paying small-cap stocks that represent the bottom 25% of the WisdomTree U.S. Dividend Index by market cap after removing the 300 largest companies.
The 700-plus stocks that make the ETF are then weighted based on dividends paid rather than market cap. So, for example, if Company A had a market cap of $200 billion and paid out $12 billion in dividends and Company B had a market cap of $200 billion and paid out $3 billion in dividends, Company A would get a higher weighting because it pays out four times as much in the way of dividends.
Unlike many of the other ETFs in this list, WisdomTree’s small-cap ETF has consumer discretionary stocks as its leading sector by weight at 21.7%, which is 3.69 percentage points higher than the next-biggest sector, industrials.
I’m a big believer in consumer discretionary stocks, especially in a strong economy; DES could be the biggest underdog of all 10 ETFs.
Type: Foreign small-cap (Latin America)
Market value: $76.8 million
Dividend yield: 6.3%
The VanEck Vectors Brazil Small-Cap ETF (BRF, $18.08) has lost more than 20% of its value in 2018. That’s not very good when you consider that Latin American stocks are down just 4%, and the S&P 500 is up 9% over the same period.
BRF tracks the performance of the MVIS Brazil Small-Cap Index, a group of 56 stocks that are either incorporated in Brazil or generate more than 50% of their overall revenue in Brazil.
The weighted average market cap of the index is $1.5 billion; the lowest stock rings in at $389 million and the highest at $3.2 billion. Consumer discretionary, utilities and information technology account for 25.8%, 21.2% and 9.6% of the portfolio, respectively.
Although BRF is down heavily in 2018, it had an annual total return of 60.1% in 2016 and 54.6% in 2017, suggesting that investors willing to endure significant volatility and buy when it’s down — as it is this year — can do very well with it.
Just don’t use it to fund your child’s college tuition.
Market value: $434.5 million
Dividend yield: 1.8%
The ProShares Russell 2000 Dividend Growers ETF (SMDV, $58.51) is 2 basis points more expensive than WisdomTree’s small-cap dividend ETF, and it also has a less attractive dividend yield.
That being said, there’s a lot to like about SMDV.
The ETF tracks roughly 60 stocks in the Russell 2000 Dividend Growth Index, which only includes dividend-paying small-cap stocks that have grown their dividends for at least 10 consecutive years. While the current yields of these stocks might not always be high, these stocks are growing their payouts over time — that means higher yield on cost down the road, plus the knowledge that you’re investing in companies that are financially secure enough to keep growing their payouts.
Another attraction of SMDV is that it’s equal-weighted, rebalancing four times a year.
And while WisdomTree’s fund beats this ProShares fund on a few statistical fronts, the SMDV has outperformed DES in two of three years since it was launched in 2015.
Market value: $104.4 million
Dividend yield: 1.3%
The JPMorgan Diversified Return U.S. Small Cap Equity ETF (JPSE, $32.09) is similar to First Trust’s ETF in that it uses risk-based portfolio construction in combination with rules-based security selection.
The JPMorgan Diversified Factor Small Cap Equity Index pulls together value, quality and momentum factors to deliver better risk-adjusted returns than a traditional market cap-weighted index.
Consumer goods and consumer services together account for about 34% of the overall portfolio, with industrials in third with a 12.6% weighting.
JPSE’s top 10 holdings include some stocks investors might be familiar with, including Boston Beer (SAM) and Pool Corp. (POOL). It also sports a low 24% annual turnover rate, so investors can sleep well knowing significant trading fees aren’t being racked up and dragging on returns.