It may be a good time to consider small-capitalization stocks and related exchange traded funds as the growth outlook and an election year could support the asset category.
For instance, investors can look at the iShares Core S&P Small-Cap ETF (NYSEArca: IJR), which tracks the S&P SmallCap 600.
“We believe small-cap stocks will experience above-average earnings growth in 2016 that in some cases is not fully reflected in valuations,” Todd Rosenbluth, Director of ETF Research at S&P Capital IQ, said in a research note.
The S&P SmallCap 600 Index is currently trading at 18.6 times 2016 estimates, compared to the 18.1 times estimates for mid-caps and 16.5 times estimates for the S&P 500 index. Moreover, the small-cap index shows a price-to-earnings growth rate of 1.3 times, a discount to its larger peers of 1.6 times for mid-caps and 1.5 times for the S&P 500.
Moreover, S&P Capital IQ Equity Strategist Sam Stovall pointed out that small-caps have advanced an average 10.9% in Presidential election years since 1980, or more than double the 4.2% gain for the S&P 500.
S&P Capital IQ also notes that a cheap ETF option, like IJR, may be a good way to capture broad exposure to U.S. small-caps. According to S&P Index Versus Active research, only 13% of all small-cap funds outperformed the S&P SmallCap 600 Index for the five years ended June 2015.
“To us, this highlights the challenges of finding small-cap funds with consistently strong records,” Rosenbluth added. “Given much higher expense ratios for mutual funds, we think small-cap ETFs are compelling alternatives.”
There are 120 small- and micro-cap U.S.-listed ETFs with an average expense ratio of 0.50%, according to XTF data. IJR has a 0.12% expense ratio.
Potential investors should also be aware that the small-cap ETFs may have differing level of sector exposure than what many are used to. For instance, IJR has a greater financial exposure of 24% than the S&P 500’s 17%, along with industrials at 17% versus 10%. However, IJR shows a smaller 12% tilt to technology, compared to the S&P 500’s 17%.
Nevertheless, investors may be exposed to potentially attractive growth rates in the more nimble small-cap category. Small-caps are expected to experience an earnings growth rate of 59%, compared to 8% for large-caps.
Investors can also track more domestically focused U.S. companies through other small-cap ETF options like the Vanguard Small Cap ETF (NYSEArca: VB), which follows the CRSP US Small Cap Index and has a cheap 0.09% expense ratio; the iShares Russell 2000 ETF (NYSEArca: IWM), which tracks the Russell 2000 Index and comes with a 0.20% expense ratio; and Schwab U.S. Small-Cap ETF (NYSEArca: SCHA), which tracks the Dow Jones U.S. Small-Cap Total Stock Market Index and has a low 0.08% expense ratio.
For more information on small-capitalization stocks, visit our small-cap category.
Max Chen contributed to this article.