Companies around the world come in all shapes and sizes, and one size definitely does not fit all portfolios. For the most effective investing in asset class exchange traded funds (ETFs) for your clients, it’s important to understand how economic conditions and other events impact corporations of different sizes. We’ve covered large-caps and mid-caps; now it’s time to talk small-caps.
What’s a Small-Cap?
Different index providers vary on their definition of “small cap” stocks. The S&P, for instance, categorizes small-caps as companies with a market capitalization of $300 million to $1.5 billion.
Small-caps are no tiny part of the market. In fact, small-cap companies make up roughly 10% of the total U.S. equities market.
Unlike large-caps, which often are internationally-known brands, small-caps are companies that investors are less likely to have heard of. But like emerging markets, small-caps are companies that have the potential to grow into something more. Those who get in on the ground floor will reap the rewards of that growth if it happens.
The Benefits of Small-Caps
While larger companies boast stability, small-caps make up for their lack of it by being far more nimble.
Smaller companies can easily adapt and make fast and effective decisions as compared to their larger, more bulky counterparts. This is also one of the reasons why small companies and small-cap ETFs are expected to perform better after a recession. Changing economic conditions and market demands require fast action and an ability to change gears seamlessly; small-caps can do this more easily than large corporations, which often have several layers of bureaucracy to work through.
Small-caps are also more thinly-traded than bigger companies. Investors who get in early on a small-cap that becomes a large company may benefit as investors get wind of the stock and buy it – pushing the price higher.
One risk in small-cap investing is that small companies often operate within a specialized or target business area. Because of their less diverse nature, these small companies would be more sensitive to economic uncertainty, which investors would see in their higher volatility. As with most volatile investments, the possibility of higher returns is also evident.
Why Small-Cap ETFs?
Given the small size of small-caps, doing research can be a time-consuming challenge. That’s why many prefer to leave the legwork to ETF providers, who have carefully built indexes of high-quality corporations. You, in turn, can own a universe of small-caps in one easy trade for your clients.
Small-cap ETFs offer different strategies in the makeup of their funds, including traditional market-cap weighted indexing, fundamental weighting based on earnings or dividends and rules-based investing that would select stocks based on quantitative measures.
This is true of all ETFs, but when it comes to small-cap ETFs in particular, watch the expense ratios. The need to buy smaller stocks can sometimes translate into higher costs for the fund.
By understanding the environments in which small-cap companies tend to perform at their peak, you can effectively invest in small-cap ETFs for your clients. You can find all of the small-cap ETFs by visiting the ETF Analyzer. Once there, you can sort them by performance, yield, expense ratio and more.
As a pro-level member, be sure to take advantage of portfolios, alerts and the watchlist on your Dashboard to find small-cap ETFs that are best for you!