Small-cap stocks and small-cap ETFs often outperform their large-cap counterparts over the long-term with the trade off being that smaller stocks are usually more volatile than their large-cap peers.
One of the primary reasons small-cap stocks outpace their larger peers is the markets often assign higher growth expectations to smaller companies. It is simple math. A small-cap stock with a market value of, say, $1 billion can more easily double or triple in size than a company with a current market capitalization of $50 billion or $100 billion.
So in theory it would be reasonable to expect that the combination of small-cap stocks and the growth factor would be rewarding for investors. It can be…over the right time horizons, but historical data indicate small-cap growth . However, the bull market is raging on and that has been a boon for growth fare, including plenty of small-cap stocks and ETFs.
What has recently been vexing about small-cap stocks is the laggard status of growth in this category. With large- and mid-cap growth funds and stocks setting a torrid pace in the first quarter, small-cap growth was left behind. Small-cap growth funds were among the in the first three months of the year.
For risk-tolerant investors seeking exposure to small-cap ETFs, here are some growth funds to consider.
SPDR S&P 600 Small Cap Growth ETF (SLYG)
Expense ratio: 0.15% per year, or $15 on a $10,000 investment.
The SPDR S&P 600 Small Cap Growth ETF (NYSEARCA:SLYG) is a basic approach to small-cap stocks dwelling in the growth space. SLYG, which tracks the S&P 600 SmallCap Growth Index, is also one of the more highly related small-cap growth funds by some , though that is not saying much as many analysts are mostly tepid on this fund style.
SLYG’s underlying index “includes stocks that exhibit the strongest growth characteristics based on: sales growth; earnings change to price; and momentum,” according to State Street. The result is a portfolio of 335 small-cap stocks with a weighted average market value of $2.07 billion.
SLYG allocates nearly 36% of its combined weight to industrial and healthcare small-cap stocks and another 29% to the financial services and technology sectors. While 2019 is not even a third of the way over, SLYG’s year-to-date gain of 13.50% is endemic of small-cap growth’s laggard ways against small-cap value. The SPDR S&P Small Cap Value ETF (NYSEARCA:SLYV), SLYG’s value counterpart, is up 17.20% this year.
Invesco S&P SmallCap 600 Pure Growth ETF (RZG)
Expense ratio: 0.35%
The name of the Invesco S&P SmallCap 600 Pure Growth ETF (NYSEARCA:RZG) makes this fund sound a lot like the aforementioned SLYG, but these are two different products and their index methodologies confirm as much.
RZG tracks the S&P SmallCap 600 Pure Growth Index, which measures growth “by the following risk factors: sales growth, earnings change to price and momentum,” .
Assigning purity to growth gives RZG a roster of 147 stocks with an average market value of $1.58 billion, numbers that are materially different than SLYG. However, purity with small-cap stocks and the growth factor is not always a guarantee of stout returns. This year, RZG’s value counterpart is beating the growth fund by 760 basis points.
Vanguard Russell 2000 Growth ETF (VTWG)
Expense ratio: 0.20%
As its name implies, the Vanguard Russell 2000 Growth ETF (NASDAQ:VTWG) is a collection of small-cap stocks from the Russell 2000 Growth Index, which is the growth offshoot of the popular Russell 2000 Index. To give investors an idea of how many small-cap stocks are classified as growth names, VTWG is home to 1,251 small-cap stocks.
While small-cap stocks, growth, value and otherwise, are generally defined as those companies with market values of no more than $2 billion, different index providers use varying methodologies, which leading significant performance differentials. The aforementioned SLYG and RZG track indexes from Standard & Poor’s while FTSE Russell issues VTWG’s underlying benchmark.
This is notable because VTWG is one of this year’s best-performing small-cap growth ETFs. Importantly, VTWG is one of the few small-cap growth ETFs that is beating its value counterpart. Up 19.90% year-to-date, VTWG is topping the equivalent Vanguard small-cap value ETF by 400 basis points. VTWG allocates 44.40% of its combined weight to the healthcare and consumer discretionary sectors.
iShares Morningstar Small-Cap Growth ETF (JKK)
Expense ratio: 0.30%
As was just noted with VTWG, an ETF’s underlying index matters. The iShares Morningstar Small-Cap Growth ETF (NYSEARCA:JKK) tracks the Morningstar Small Growth Index and there must be something in that water because JKK is up 22.30% this year, easily good for one of the best showings among small-cap growth funds.
This year, JKK has been more volatile than some rival small-cap growth funds, but its three-year is actually slightly lower than the comparable metric on the Russell 2000 Growth Index.
JKK allocates about 44.60% of its combined weight to the healthcare and technology sectors. Combining small-cap stocks from those sectors is common among growth funds, but there is something to consider with those sector allocations. Small-cap stocks in the healthcare and technology sectors frequently sacrifice cash flow generation and profitability to grow revenue. Some even take on debt to bolster growth, meaning there some small-cap stocks with the growth designation that are not as financially sturdy as some investors would like those companies to be.
Invesco Russell 2000 Pure Growth ETF (PXSG)
Expense ratio: 0.39%
The Invesco Russell 2000 Pure Growth ETF (NYSEARCA:PXSG) is another example of an ETF that assembles small-cap stocks with the growth label while adding a layer of growth purity. PXSG’s methodology is working this year as the fund is up 18.28%, an advantage of about 410 basis points over its value rival.
The growth purity qualifier is significant because PXSG holds just 301 stocks, or less than a quarter of the amount found in VTWG, which like PXSG tracks a Russell index. PXSG devotes over 44% of its weight to small-cap stocks that are healthcare or technology names.
This fund highlights some of the aforementioned risks associated with small-cap stocks from those sectors. PXSG has a negative return on equity and investors will pay up for that privilege with a price-to-earnings .
iShares Micro-Cap ETF (IWC)
Expense ratio: 0.60%
Micro caps are different than small-cap stocks. The former typically have market values below the $200 million to $250 million that is the beginning part of small-cap stock territory. Due to lack of analyst coverage and institutional participation in the micro-cap arena, stock picking here is difficult, but the iShares Micro-Cap ETF (NYSEARCA:IWC) is a solid idea for investor seeking some micro-cap exposure.
This year, IWC up 13.30%, but that trails broader gauges of small-cap stocks. While the fund’s is only moderately higher than broader small-cap stock funds, there are sector-level concentration concerns as healthcare and financial services names combine for almost half IWC’s weight.
Additionally, IWC’s annual fee of 0.60% is higher than those found on standard small-cap growth ETFs due to some of the liquidity issues associated with micro-cap stocks, That said, IWC’s earnings multiples imply micro caps are somewhat inexpensive relative to diversified gauges of small-cap stocks.
Invesco S&P SmallCap Information Technology ETF (PSCT)
Expense ratio: 0.29%
The Invesco S&P SmallCap Information Technology ETF (NASDAQ:PSCT) is not a dedicated small-cap growth fund, but it is fairly close. PSCT holds 88 small-cap stocks, 52.49% of which are classified as growth stocks compared to a 19.82% weight to value stocks.
As mentioned throughout this piece, there are risks associated with the combination of small-cap stocks and the technology sector. However, a point in favor of PSCT is the isolation of small-cap stocks and technology as represented by this fund has led to out-performance of many of the growth funds highlighted here. Over the past three years, PSCT has handily outperformed the Russell 2000 and S&P SmallCap 600 growth benchmarks.
The strike against PSCT is not its performance against comparable small-cap peers. It is the fund’s risk-adjusted returns against the large-cap Nasdaq-100 and S&P 500 Technology indexes. Against those benchmarks, PSCT does not compare favorably.
Todd Shriber does not own any of the aforementioned securities.
