Small-cap stocks and exchange traded funds are noticeably lagging their larger peers, but some small-cap exchange traded funds could be uniquely positioned to deliver for investors should the segment rebound.
That includes the Schwab Fundamental U.S. Small Company ETF (NYSEArca: FNDA). FNDA, which launched in 2013, tracks the performance of the Russell Fundamental U.S. Small Company Index, which includes the bottom companies that weight below 87.5% from the Russell 3000 Index. The ETF is up about 2.5% year-to-date, putting it just ahead of the widely followed S&P SmallCap 600 Index.
“This fund offers broad exposure to small-cap U.S. stocks but weights them on fundamental measures of size, including sales (adjusted for leverage), retained operating cash flow, and dividends plus share buybacks, rather than market cap,” said Morningstar in a recent note. “This causes the fund to tilt toward stocks trading at low multiples of these metrics and away from stocks trading at higher valuations. However, it does not exclude growth stocks.”
On the back of the Federal Reserve’s recent interest rate hike and amid expectations of more from Fed later this year, some investors may be concerned about how small-caps will endure increased borrowing costs. Historically, smaller stocks have performed admirably as rates have risen.
A Fed rate hike would also help support the U.S. dollar, which would make U.S. exports more expensive overseas and diminish revenue for larger companies with a bigger international footprint. In contrast, small-cap stocks are focused on domestic markets, and Sam Stovall noted that growth projections for U.S. small-caps are better than those for large-cap stocks.
Small-caps are also focused on the domestic economy and have less direct exposure to global geopolitical uncertainty and currency risks, as opposed to large-cap companies that have an international footprint, which may be affected by overseas risks and a strengthening U.S. dollar.
FNDA holds over 800 stocks and its sector tilts are highly cyclical, which could work in the ETF’s favor as interest rates climb.
“The fund currently has greater exposure to industrials and consumer cyclicals than the Russell 2000 Index and less exposure to healthcare stocks. Its holdings tend to trade at slightly lower average multiples of forward earnings than the constituents in the Russell 2000 Index. The portfolio also has a modestly larger market-cap orientation than that benchmark,” according to Morningstar.
Following a recent fee cut, FNDA charges 0.25% per year, making it one of the least expensive smart beta small-cap ETFs on the market.