ETFs make small-cap stocks less risky.
Small-cap stocks are the fireworks kiosk of the stock market. Several of them have the potential to go sky-high and perform amazing feats for their owners, while others very well could fizzle out and amount to nothing. That high-risk, high-reward tradeoff makes small caps among the riskiest assets out there, but that’s where exchange-traded funds can step in and lend a hand. Small-cap stock ETFs allow investors to invest in large baskets of these more volatile but upside-packed equities, thinning out risk (and often doing so for a reasonable fee).
Guggenheim S&P SmallCap 600 Equal Weight ETF (ticker: EWSC)
One of the best examples of how an ETF can mitigate the risks of holding small-cap stocks is Guggenheim’s EWSC, which invests in the small-company-focused Standard & Poor’s 600 index, but with a twist. Unlike conventional market cap-weighted funds that allocate assets to stocks based on their size, EWSC equally weights each of its 601 stocks at every rebalancing, ensuring that every company has just as much ability to influence the direction of the fund. Thus, even top holdings Restoration Hardware Holdings (RH) and fiber-optic networking products provider Applied Optoelectronics (AAOI) are merely fractional weights, virtually eliminating single-stock risk.
Expenses: 0.41 percent, or $41 annually on every $10,000 invested
Vanguard Small-Cap Value ETF (VBR)
Most investors buy small-cap stocks for their explosive growth potential, and many simply ignore traditional valuation metrics as they chase these companies to the moon. But while holdings such as integrated IT company CDW Corp. (CDW) and natural gas pipeline operator Atmos Energy Corp. (ATO) won’t raise the hair on your arms, Vanguard’s VBR has proven the merits of chasing more agile businesses with cheaper valuations by outperforming its growth and blended counterparts over the past three- and five-year periods. VBR also features Vanguard’s razor-thin expenses, which are cheaper than 95 percent of comparable options.
Expenses: 0.07 percent
First Trust Nasdaq ABA Community Bank Index Fund (QABA)
Certain sectors really shine when you carve out their smaller components, and that’s the principle that First Trust’s QABA is built upon. QABA is a 172-holding fund that holds financial stocks — excluding the 50 largest banks or thrifts, as well as anything with an international or credit-card specialization — that trade on the Nasdaq composite. These more community-focused banks are poised to thrive alongside American economic growth, but they also have quick “pop” potential thanks to the sector’s merger-happy nature as larger banks look to accumulate assets.
Expenses: 0.6 percent (includes 1-basis-point fee waiver)
PowerShares S&P SmallCap Consumer Staples Portfolio ETF (PSCC)
Most investors associate the consumer staples sector with the likes of Procter & Gamble Co. (PG) and Colgate-Palmolive Co. (CL), but they’d be short-changing themselves if they ignored the smaller companies in the space. Companies like PSCC holdings Darling Ingredients (DAR), which develops and produces sustainable solutions for food, feed and fuel, and poultry producer Sanderson Farms (SAFM) might be more niche, but they don’t lack for performance. Even including the ample dividends of its large-cap brethren, PSCC still has managed to outperform the Consumer Staples Select Sector SPDR Fund (XLP) over every major time frame since 2010 inception.
Expenses: 0.29 percent
Sprott Junior Gold Miners ETF (SGDJ)
Gold miners are, as the name implies, companies that operate mines and extract the physical metal from the earth. However, there’s a group of smaller companies that are associated more with the actual exploration and testing of properties to discover deposits and determine how valuable they are. Junior miners are a leveraged play on gold prices, as they tend to move more drastically than the metal itself, making them perfect for aggressive investors. Sprott’s SGDJ invests in a bundle of 36 such stocks, including IAmGold Corp. (IAG) and Alamos Gold (AGI), that top out at $2.5 billion in market cap.
Expenses: 0.57 percent
ALPS Medical Breakthroughs ETF (SBIO)
You can find a veritable powder keg of small-cap potential in the biotechnology and pharmaceutical industries, where small companies with one or two trial-stage drugs explode by double digits on the regular amid data reports and FDA rulings, but can collapse just as quick. SBIO reduces the risk by investing in less than 100 such stocks, with quality requirements such as an average daily volume of $1 million-plus, and enough cash on hand to last 24 months at the company’s current burn rate. Moreover, holdings are limited to 4.5 percent of the fund’s weight at rebalancing.
Expenses: 0.5 percent
iShares MSCI China Small-Cap ETF (ECNS)
One of the best places to chase small-cap stocks is in emerging markets, where rapidly expanding middle classes are helping to drive not just multinational corporations, but also smaller, more domestic-focused companies. There are few better places to start your search than China, whose economy is still expanding at a robust clip of nearly 7 percent. ECNS benefits from heavy concentrations in consumer stocks, a play on increased Chinese discretionary spending, as well as IT as businesses grow in kind. Top among ECNS’ roughly 420 holdings are laminates manufacturer Kingboard Chemical and online financial services outfit Credit China FinTech Holdings Limited.
Expenses: 0.64 percent
VanEck Vectors India Small-Cap Index ETF (SCIF)
Another hotbed of international growth is India, where GDP is expected to “recover” to above 7 percent this fiscal year as Prime Minister Narendra Modi continues to push financial reform. Indian small-cap ETF SCIF has clobbered U.S. (and most international) markets over the past 18 months or so as India has gotten its economic house in order. The fund is like ECNS in many respects, including large weightings in consumer, financial and industrial stocks, though real estate is a much smaller part of the picture at less than 4 percent of assets.
Expenses: 0.78 percent
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