Tiny Stocks, Big ETF Returns

Micro-cap stocks, those with market values ranging from $50 million to $300 million, often get a bum rap. Some investors associate micro-caps with dangerous penny stocks. Others speculate that low market caps always mean increased volatility.

It is true that stock-picking in the micro-cap universe is trickier than it is with large caps. Some investors might suggest that since the small-cap universe, by definition, includes stocks with market caps up to $2 billion that is easier to pick winners among those names than it is with micro-caps. However, low market value stocks have been helping drive the broader market higher and the good news is ETFs have can help solve some of the micro-cap conundrum for investors. [Small-Cap ETFs Driving Market to New Highs]

Micro-cap ETFs have been contributing in significant fashion to the small stock rally. On Thursday, 15 ETFs hit new all-time highs. Two, the iShares Micro-Cap ETF (NYSE: IWC) and the First Trust Dow Jones Select MicroCap Index (NYSEArca: FDM), were micro-cap ETFs. Another micro-cap ETF, the Guggenheim Wilshire Micro-Cap ETF (NYSEArca: WMCR) hit a new 52-week high. Those ETFs are up an average of 29.6% year-to-date. [Micro-Cap ETFs for a Market Rebound]

Before jumping in, there are some issues investors need to evaluate with micro-cap ETFs. Regarding IWC, that fund “does seem to be in need of a rest, if not pullback at this time. It is marginally overbought according to traditional momentum indicators, and it is trading at the top of its rising trend channel,” reports Michael Kahn for Barron’s.

Then there are the questions about just how many true micro-caps these ETFs hold. With the stocks performing well, their market caps are rising and the average market value of IWC’s 1,352 holdings is close to $360 million. The median market cap of FDM’s 264 stocks is $405 million. While neither ETF gives any stock a weight of more than 1.3%, it is interesting to note that FDM’s largest holding, Krispy Kreme Doughnuts (NYSE: KKD), has a $1.3 billion market cap. Leap Wireless (NasdaqGM: LEAP), one of IWC’s top holdings, has a market value of $1.35 billion.

A critical view would be that it is really small caps residing in micro-cap ETFs that are doing the heavy lifting for these funds.