Small-Cap/ESG Combination Offers Benefits | ETF Trends

With large-cap equities sagging, it’s understandably difficult for investors to get enthusiastic about small-cap stocks and the relevant exchange traded funds.

However, the combination of small stocks and environmental, social, and governance (ESG) virtues could provide benefits to investors, even in this tricky market setting. The SPDR S&P SmallCap 600 ESG ETF (ESIX) is a prime idea for investors looking for a quality avenue to smaller stocks.

Perhaps to the surprise of novice investors, despite the aforementioned small-cap struggles, ESIX is relevant today because it could prove more sturdy than expected in the event of a recession.

“Bank of America economists forecast a mild recession starting now, with negative q/q GDP growth from 1Q22-1Q23,” wrote BofA analyst Jill Carey Hall in a recent report. “Several of the most correlated indicators with small cap returns have been deteriorating (PMIs, consumer/small biz sentiment, leading indicators) and our high yield strategists see further spread widening, though to lower levels vs. prior recessions (HY note). As such, we would be cautious on small caps in the coming months, where we expect volatility and risk of further downside.”

Not surprisingly, some market participants are currently skittish about small-caps due to rising recession chatter. Indeed, small-caps’ track record during economic contractions isn’t stellar, but if a recession does set in, this one could be different. That could be to the benefit of ESIX investors.

“Aren’t recessions worse for small caps? Yes – but this time, we think risks are largely discounted, and small caps are better positioned to weather today’s backdrop of higher-for-longer inflation, deglobalization, risks to COVID beneficiaries (big Growth stocks), and geopolitical risks,” added Hall. “And small cap corporates have been guiding above consensus (with guidance ratio improving) vs. below-avg./deteriorating guidance in large. Stagflation typically isn’t good for equities, but small caps have outperformed large.”

ESIX debuted in January 2022 and follows the S&P SmallCap 600® ESG Index, which is the ESG derivative of the famed S&P SmallCap 600. That index relationship is relevant to investors because there’s a profitability requirement for entry into the S&P SmallCap 600. That mandate isn’t copied by all small-cap benchmarks, but it could prove advantageous for investors in the event of a deep recession.

ESIX holds 394 stocks, about half of which hail from the financial services, industrial, and technology sectors. The weighted average market value of its components is $2.21 billion.

For more news, information, and strategy, visit the ESG 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.