In the equities market, stocks of varying market capitalization come with different levels of risk and rewards. So far this year, riskier micro-capitalization weighted exchange traded funds have been outpacing all other asset categories.
Micro-cap companies have a market capitalization of around $50 million and $300 million, or less than small-cap stocks. Typically, investors will notice that larger capitalization stocks are less risky, generating smaller but more steady returns. In comparison, smaller company stock see greater swings, but the added risk comes with potentially greater returns.
“By size, micro-caps make up less than 2% of total market capitalization,” according to Morningstar analyst Michael Rawson. “From 1926 to 2012 they’ve earned about 3% annualized over large caps, a return bonus traditionally called the size premium. Investors expect excess return from them because micro-cap stocks are often speculative and trade with much greater volatility than large caps.”
So far this year, the size premium seems to be holding up. For instance, the largest micro-cap-related ETF, the iShares Micro-Cap ETF (NYSEArca: IWC), which has over $1 billion in assets, has gained 6.2% year-to-date and is up 37.2% over the past year, outperforming other asset categories.
In contrast, the S&P 500 Index has gained 1.8% year-to-date and rose 22.7% over the last year. The S&P MidCap 400 Index returned 2.9% so far this year and increased 20.6% over the past year. Meanwhile, the S&P SmallCap 600 Index is up 2.2% year-to-date and 27.9% over the last year while the broader Russell 2000 Index of small-cap stocks is 3.3% higher this year and 27.6% higher over the past year.
While IWC has produced some attractive returns, potential investors should be aware that liquidity issues in the underlying micro-cap stocks can drag on performance of the overall fund as the underlying index’s buy and sell orders can move prices against the fund, Rawson added.
IWC tracks 1,344 micro-cap stocks and has a 0.72% expense ratio. Top sectors weights include financial 26.4%, health care 19.8% and tech 13.9%.