Let’s take U.S. small caps for a moment, for it is here that WisdomTree has been conducting a very interesting experiment in real time. We created an Index, the WisdomTree SmallCap Earnings Index, which in effect includes all the profitable small-cap companies in America and then weights them once a year based on the profits they generated in the prior year. It’s a broad-based small-cap Index, including nearly 900 stocks with an aggregate market capitalization of nearly $700 billion. Over the past seven years it has had a correlation to the Russell 2000 Index of about .98, yet it’s outperformed the Russell 2000 by more than 2 percentage points annualized over that period, and by more than 500 basis points annualized over the last five years.
WisdomTree SmallCap Earnings Index vs. Russell 2000 Index (2/1/2007—12/31/2013)
Remember, in the small-cap space in the U.S. there are literally tens of billions of ETF dollars tracking the Russell 2000. Billions more track the S&P SmallCap 600 and the relatively new capitalization-weighted small-cap indexes from MSCI and CRSP. Each of these cap-weighted indexes has its own unique selection methodology, so defining what exactly is small-cap beta is very much in the eye of the beholder. I believe that this choice is a positive, because it gives advisors and advisory firms more latitude to consider smart beta alternatives such as the WisdomTree SmallCap Earnings Index.
In the next part of this series, we’ll take a look at what happens when you weight mid- and large-cap segments of the U.S. by earnings rather than by market value.
1Towers Watson, “Understanding Smart Beta,” July 2013.
2Source: Andrew Clare et al., “An Evaluation of Alternative Equity Indices, Part 2: Fundamental Weighting Schemes,” Cass Consulting, March 2013.
3Source: Dodd Kittsley, “What You Need to Know about Strategic Beta,” Blackrock, 1/15/14.
Important Risks Related to this Article
Investments in emerging, offshore or frontier markets are generally less liquid and less efficient than investments in developed markets and are subject to additional risks, such as risks of adverse governmental regulation and intervention or political developments. Investments focusing on certain sectors and/or mid- or small cap companies increase their vulnerability to any single economic or regulatory development. This may result in greater share price volatility.