A Small-Cap Conundrum-By Zoe Van Schyndel, CFA
February 15, 2007
Small-cap stocks have been solid performers over the last couple of years, and investors are fortunate that they can find many exchange-traded funds to choose from in this area. Close to 20 ETFs, in fact, have "small cap" in their moniker.
However, not all small-cap ETFs are alike. The funds' returns, the fees they charge, and the indices that the funds follow can vary significantly. And although the majority of small-cap ETFs track U.S. stocks, some now follow global indexes, and others provide investors the ability to short or magnify their exposure to this segment of the market.
Barclays has the largest number of ETF offerings and is also the current favorite among investors who have placed close to $26 billion in a half-dozen small-cap funds from this ETF sponsor. The closest competitor by dollar value, Vanguard, is far behind the sector leader, with just about $2 billion in three funds.
Performance writ large
Paradoxically, two of the best-performing small-cap ETFs are funds with the largest amount of assets -- both from Barclays. The biggest one, iShares Russell 2000 (NYSE: IWM), currently has nearly $10 billion in assets, and its low expense ratio of 0.2% is an additional positive feature. The second-largest fund, iShares Russell 2000 Value (NYSE: IWN), has $4.5 billion in assets and can claim a slightly better performance record than IWM but also charges a higher expense ratio of 0.25%. In 2006, the 23% return of IWN compared with the 18% return of IWM more than covered the difference in costs, but keep in mind that since the tech crash of early 2000, both value stocks and small caps have been on a tear. When this outperformance finally comes to an end, you may face a double hit with IWN.
Since Barclays' funds currently have the most assets, it makes sense to take a closer look at the indices that these funds track.
The Russell 2000 includes the smallest 2,000 securities in the Russell 3000 and has an average market cap of $1.2 billion. Since it contains only small firms, the index represents a mere 3% of the value of the overall market.
If you are looking for the most diversification, then you should select a fund that tracks the Russell. Another consideration is that Russell's approach to selecting stocks is quantitative, while Standard & Poor's is more qualitative. Russell looks only at market cap to determine which companies go into the index. S&P, meanwhile, takes a more qualitative approach and runs its indices by committee, which means there is subjectivity in which companies are included or excluded.
Midway through 2006, WisdomTree launched its International SmallCap Dividend Fund (NYSE: DLS), which focuses on the small-cap, dividend-paying companies in the industrialized world outside the U.S. and Canada. Since the fund's inception in mid-June of 2006, DLS has racked up a 25% return, more than paying for its 0.58% expense ratio. With global markets on a tear in 2006 and the dollar weakening, this fund has already gathered more than $180 million in assets.