Refreshed Approach to Small Caps Is Standing Tall | ETF Trends

Small-cap equities and the related exchange traded funds are getting plenty of notoriety these days, but one ETF meriting more consideration, owing to a unique approach, is the ERShares International Equity ETF (NYSEARCA: ERSX).

ERSX is benefiting from the rally in domestic small-caps, but investors shouldn’t let home country bias get in the way because there’s a broader universe of ex-US small stocks, many of which are growth names from developing economies. The ERShares ETF provides exposure to those benefits without an all-in commitment in what can be a trick asset class to navigate.

“Investors are getting more comfortable taking risks thanks to continued progress on the development and rollout of coronavirus vaccines and an economic stimulus package in the US, both of which could contribute to economic recovery in 2021. These factors are only adding to the optimism around smaller companies,” according to Business Insider.

Superior Alternative

ERSX offers a better approach to small caps than what investors get with many of the most widely followed benchmarks providing exposure to this asset class. In fact, the ERShares can be seen as a higher quality alternative to Russell 2000 Index funds.

“The Russell 2000 holds the 1,001st to 3,000th largest U.S. stocks and weights them by market cap. The lower bound of this range is lower than other small-cap indexes. Its competitors tend to hold slightly larger-cap names,” according to Morningstar. “Smaller-cap companies tend to be less profitable and have weaker competitive advantages than larger-cap companies. This hurts the Russell 2000’s performance as competitor indexes hold relatively larger names. These smaller stocks are also less liquid, which can increase trading costs and thus hurt performance.”

ERSX selects the most entrepreneurial, primarily Non-US Small Cap companies, that meet the thresholds embedded in their proprietary Entrepreneur Factor (EF). ERShares’ ETF delivers strong performance across a variety of investment strategies without disrupting investors’ underlying risk profile metrics. Their geographic diversity enables them to harness global advantages through additional returns associated with currency fluctuations, strategic geographic allocations, comparative trade imbalances, and relative supply/demand strengths.

ERSX’s rich, layered approach can also buffer some of the volatility associated with the Russell 2000 rebalancing.

“Another issue is the index’s reconstitution. If the 1,001st largest U.S. stock’s price appreciates, it graduates from the index and is removed, as is the 3,000th stock if its price depreciates. The index makes these changes on a single day–rather than spreading changes over multiple days–and thus incurs unnecessary costs,” notes Morningstar. “This issue is most costly for the Russell 2000’s lower bound. Since transaction costs are higher for the smaller, less liquid stocks, reconstituting the smallest members with no buffering hurts performance.”

For more on entrepreneurial strategies, visit our Entrepreneur ETF Channel.

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.