The iShares Russell 2000 ETF (NYSEArca: IWM) and the iShares Core S&P Small-Cap ETF (NYSEArca: IJR), as their names imply, are both diversified small-cap exchange traded funds, but they are not identical twins.

As its name implies, IWM is home to nearly 2,000 stocks while IJR tracks an index that usually features 600 members. What these titans of small-cap ETFs share in common are large health care allocations, which with small caps usually means biotechnology stocks. That is a positive trait when biotechnology shares are rising, but when those stocks pullback, supposedly diversified small-cap ETF can be pinched. [Despite Broad Market Slowdown, Small-Cap ETFs Are Outperforming]

“A flood of initial public offerings in recent years has left the small-cap universe littered with tiny biotech companies that have promising drugs but often no revenue. The biotech sector accounts for 3% of the Standard & Poor’s 500’s weight, the highest ever. But biotech represents more than double that heft—7%—in the Russell 2000 index of small-company stocks, according to XTF. That’s more than enough to move the dial in terms of performance: In the first half of 2015, biotech stocks were responsible for 1.9 percentage points, or 41%, of the Russell 2000’s 4.8% return, according to Bank of America Merrill Lynch. Biotech has been the most influential sector in the Russell 2000 this year,” reports Chris Dieterich for Barron’s.

IWM’s health care weight is nearly 17% while IJR features a health care allocation of close to 14%. Year-to-date, the ETFs are up an average of 1.4% and have been struggling since late in the second quarter. Those struggles, which are not entirely attributable to their health care weights, show IWM, IJR and other small-cap ETFs are disappointing investors that bet on these funds as beneficiaries of a stronger dollar.

While a pullback in small-cap biotech names is unlikely to leave IJR and IWM unscathed, the potentially more problematic issue for these ETFs is the average weight of 24% the pair sport to the financial services sector. Problematic because smaller financial services companies are perceived as vulnerable to increases in short-term interest rates, the very rates the Federal Reserve will hike when it finally boosts borrowing costs. [Leadership From Small-Cap ETFs]

iShares Russell 2000 ETF

Tom Lydon’s clients own shares of IWM.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.