As investors build a well-diversified investment portfolio, small-capitalization stock exchange traded funds may help enhance returns over the long haul.
Small-cap stocks may compensate investors with higher return potential. Over the very long term, small-cap stocks have generated higher returns than their larger counterparts, but investors should note that small-caps also experience short-term periods of underperformance in between.
Looking ahead, the U.S. economy is still slowly expanding and the Federal Reserve is embarking on a tighter monetary policy outlook. Small-caps, though, can still navigate through a slowly rising rate environment. Smaller companies, which focus on U.S. markets, are less exposed to a stronger U.S. dollar as rates rise, which would more negatively affect larger corporations with a global footprint. Additionally, periods of rising rates also coincide with expanding economies, which often benefit smaller companies.
Small-caps are focused on the domestic economy and have less direct exposure to global geopolitical uncertainty and currency risks, as opposed to large-cap companies that have an international footprint, which may be affected by overseas risks and a strengthening U.S. dollar.
Merger and acquisition activity can also continue to pick up ahead, with larger companies seeking to expand by purchasing smaller businesses to complement or expand their markets. Larger firms may be more apt to engage in M&A activity now, especially with interest rates and financing costs still near lows. The Trump administration has shown its willingness to push through deregulation, including a corporate tax holiday for larger companies, which may help bigger companies add to their coffers and help finance more acquisition targets.
Investors interested in gaining exposure to the small-cap segment ahve a number of options available For instance, the iShares Core S&P Small-Cap ETF (NYSEArca:IJR) follows the S&P SmallCap 600 Index, Vanguard Small Cap ETF (NYSEArca:VB) tracks the the CRSP US Small Cap Index, iShares Russell 2000 ETF (NYSEArca:IWM) reflects the benchmark Russell 2000 Index, and the SPDR S&P 600 Small Cap ETF (NYSEARCA:SLY) is based off the S&P 600 SmallCap Index.
Beyond the traditional beta-index small-cap ETFs, there now a number of smart beta or factor-based ETF options as well. For example, the Schwab Fundamental U.S. Small Company ETF (NYSEArca:FNDA) offers broad exposure to small-cap U.S. stocks but weights them on fundamental measures of size, including sales, retained operating cash flow, and dividends plus share buybacks, rather than market cap. The Oppenheimer Small Cap Revenue ETF (NYSEArca: RWJ) allows investors to gain exposure to the same securities as the S&P 600 Index but also ranks holdings by top line revenue, instead of market capitalization. The PowerShares S&P SmallCap Low Volatility Portfolio (NYSEArca:XSLV) takes the securities that exhibit the lowest volatility from the benchmark S&P SmallCap 600 Index.
For more information on small-capitalization companies, visit our small-cap category.
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