Spice Up Your Portfolio With Small Cap ETFs
The Dynamic Wealth Report
January 22, 2010
by Corey Williams, Editor
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%.
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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.
• Rio Tinto (RTP) was upgraded by HSBC Securities
this week. They now have an overweight rating on the stock. The mining
and exploration company has come under heavy selling pressure on news
that Chinese banks will slow lending.
• Google (GOOG) was downgraded to hold by Collins
Stewart. The search engine giant came up short of some analysts’ revenue
growth estimates.
• Oppenheimer started coverage on China XD Plastics
(CXDC) this week with an outperform rating. The maker of plastic
components for the red hot Chinese auto market is seeing strong growth.
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