Spice Up Your Portfolio With Small Cap ETFs

| January 22, 2010 | 0 Comments

It’s no secret small cap stocks tend to outperform large caps in the early stages of an economic recovery.  Companies with market caps under $1.2 billion give investors huge potential for growth.

It was certainly true in 2009 as the markets roared back after bottoming in early March.  The Russell 2000 and the S&P Small Cap 600 were both up 82% from March through the end of ‘09.  During the same period, the S&P 500 large cap stocks were up 66%.

Small cap stocks outpaced large caps by 16%.

That’s an additional $1,600 profit on a $10,000 investment over a short nine month period.  Clearly, adding small cap stocks to your portfolio at the right time can deliver outsized gains.

If you want to invest in a universe of these small cap stocks, your options are limited.  ETF providers have only offered a few choices for investors in small cap stocks.

iShares for example offers ETFs on Russell 2000, S&P 600, and a Morningstar small cap index.  They also offer ETFs on each of the indexes focused on growth and value style.  Basically you can use ETFs to add the entire universe of small caps to your portfolio.

It’s a good way to get exposure, but it doesn’t give you much flexibility.

The glaring hole in small cap ETFs is the lack of sector specific ETFs. There’s really no way for investors to drill down into the most profitable areas of small cap stocks.

But that’s about to change.

PowerShares is about to rollout the first ever sector specific small cap ETFs.  All I can say is… it’s about time!

PowerShares new ETFs will divide the S&P Small Cap 600 stocks according to the ten GICS (Global Industry Classification Standard) sectors.  Here’s the list…

  • PowerShares S&P SmallCap Consumer Discretionary Portfolio
  • PowerShares S&P SmallCap Consumer Staples Portfolio
  • PowerShares S&P SmallCap Energy Portfolio
  • PowerShares S&P SmallCap Financials Portfolio
  • PowerShares S&P SmallCap Health Care Portfolio
  • PowerShares S&P SmallCap Industrials Portfolio
  • PowerShares S&P SmallCap Information Technology Portfolio
  • PowerShares S&P SmallCap Materials Portfolio
  • PowerShares S&P SmallCap Telecommunication Services Portfolio
  • PowerShares S&P SmallCap Utilities Portfolio

It’s an exciting development.  However, I can already see a few problems.

So here’s a word of caution… Look at the holdings of each ETF before charging in.

Reviewing the holdings of an ETF should always be part of your due diligence process.  It’s going to be even more critical with these sector specific small cap ETFs.

The potential downfall for PowerShares is their use of the S&P 600 stocks and GICS sectors.  There aren’t enough stocks in each sector of S&P 600 to support an ETF.

Just as an example, there are only 14 utility stocks and 5 telecom stocks in the iShares S&P SmallCap 600 Index Fund (IJR).

The five telecom stocks have a combined market cap of around $2 billion. Building an ETF around five stocks with a small market cap doesn’t make much sense to me.

I have to ask… why even bother with a small cap telecom ETF?  The industry is dominated by major players.  And the small cap companies are all struggling.

I’m actually a little surprised PowerShares isn’t using the Russell 2000 universe of small cap stocks.  It would have added an additional 1,400 stocks and spread the concentration of each sector across more stocks.

The point is sector specific small cap ETFs are an exciting development. They’ll be a great way to spice up your ETF portfolio.  However, make sure you do your homework.  Some of these sectors can be a bit dicey.

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Category: ETFs

About the Author ()

Corey Williams is the editor of Sector ETF Trader, an investment advisory service focused on profiting from ETFs and the economic cycle. Under Corey’s leadership, the Sector ETF Trader has become one of the most popular and successful ETF advisories around. In addition to his groundbreaking service, Corey is the lead contributor to ETF Trading Research, where he shares his insights about ETFs and financial markets on a daily basis. He’s also a regular contributor to the Dynamic Wealth Report and the editor of one the hottest option trading services around – Elite Option Trader.

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