Micro-cap stocks have long held the allure of high profits, but those profits have come at the cost of higher risk than that of stocks of larger size. Exchange traded funds (ETFs) have been able to moderate that risk slightly by allowing investors to put their money toward a basket of micro-cap stocks instead.
What Are Micro-Caps?
Micro-caps are the smallest publicly traded companies around, with less than $300 million in market capitalization. Typically this means that the company in question is either in its infancy stage or on its way down from being a larger company.
You may or may not have heard of many micro-cap companies. Some of the better-known names include Ruby Tuesday (NYSE: RT) and Kenneth Cole (NYSE: KCP).
Finding solid micro-caps can be a challenging and time-consuming task. Smaller names naturally generate less coverage, so researching them may require additional legwork.
Micro-Caps and Risk
Micro-caps have some real benefits.
For one, they have a lower correlation with large-cap stocks. For instance, some micro caps have a 0.60 correlation with the S&P 500. Most micro-caps may be found on the NASDAQ, OTC BB or the pink sheets.
For another, as with small-cap corporations, their smaller size means they’re more nimble and can shift according to market conditions.
But the most common risks found in micro-cap companies include high debt or bankruptcies in some cases.
It should be noted that many companies categorized as micro-caps have little or no trading volumes, which makes them difficult for an ETF to buy, while other stocks may have market prices less than $1 a share, which fund managers usually don’t touch.
Micro-Cap ETFs
Micro-cap stocks, although risky, can have a place in portfolios. The obvious two methods to investing in these type of stocks are through ETFs and individual equities.
The big advantage with micro-cap ETFs is that your risk is spread out across multiple companies, so your investment doesn’t go down with the ship. Another advantage is the time savings – providers do the research and build the funds, you simply compare and buy the one that’s best for your clients.
A word of caution, however: micro-cap ETFs have relatively high turnover, since component companies often grow too big to be considered micro-caps or they do the reverse and disappear altogether.
The three available micro-cap ETFs are:
iShares Russell Microcap Index Fund (NYSEArca: IWC). IWC tries to reflect the Russell Microcap Index, which is made up of the smallest 1,000 stocks in the Russell 2000 small-cap index, along with the next 1,000 stocks under.
First Trust Dow Jones Select MicroCap Index Fund (NYSEArca: FDM). FDM tries to reflect the Dow Jones select MicroCap Index, which includes liquid stocks and stocks with strong fundamentals trading on the NYSE and Nasdaq stock market.
PowerShares Zacks Micro Cap Portfolio (NYSEArca: PZI). PZI tries to reflect the Zacks Micro Cap Portfolio, which has a “proprietary composite scoring system based on relative value and momentum.”
To research any of these ETFs further, click the ticker symbol to be taken to the ETF Resume, where you can view holdings, the prospectus and long-term performance. To sort and compare all three ETFs, stop by the ETF Analyzer.
As a pro member, you also have the ability to set up watchlists and trading alerts for these and other ETFs!