Small-Cap ETFs Still Have a Place in Long-Term Portfolios

April 21st at 4:32pm by Tom Lydon

Small-capitalization stocks and related exchange traded funds were caught up in the recent sell-off, but some asset managers are still pointing to better long-term potential.

The iShares Russell 2000 ETF (NYSEArca: IWM) has declined 4.1% over the past month while the S&P 500 rose 0.5%. However, IWM has gained an average annualized 8.3% over the past 10 years, whereas the S&P 500 returned an average 7.3%.  [ETF Chart of the Day: Super Small Caps]

Deutsche Asset and Wealth Management portfolio managers argue that global small- and mid-cap stocks are a better choice in the current environment for long-term investors, reports Steven Russolillo for the Wall Street Journal.

Small-caps have outperformed large-caps by 2.4% on an annual basis since 1926, according to Deutsche data. The firm argues that smaller stocks outpace larger companies because small-caps are less affected by global economic problems. [Small-Cap ETFs to Capture Europe’s Budding Growth]

Investors, though, have to comfortable with small-cap stocks’ underperformance during times of increased volatility.

“Smaller-cap stocks often lack economic moats, or sustainable competitive advantages,” according to Morningstar analyst Michael Rawson. “Consequently, smaller stocks tend to be less profitable and less resilient in the face of economic turbulence.”

Deutsche remains bullish on small-caps despite a robust five-year rally – the Russell 2000 has gained 232% from the March 2009 low, whereas the S&P 500 is up 175% and the Dow Jones Industrial Average rose 150%.

“We believe after three years the performance potential of small-cap stocks may outweigh their volatility,” Deutsche said in a white paper. “Therefore, in our opinion, investors with time horizons of greater than three years may wish to consider allocating a portion of their equity portfolios to small-cap stocks.”

iShares Russell 2000 ETF

IWM_ETF

For more information on small capitalization stocks, visit our small-cap category.

Max Chen contributed to this article.

Full disclosure: Tom Lydon’s clients own shares of IWM.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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