As measured by the Morningstar U.S. Large, Mid and Small Cap indexes, small-cap equities were the worst performers this year.
With cyclical value stocks rallying earlier in the year, small-cap stocks started 2021 on strong footing, but as volatility rose in the second half of 2021, investors sought the comforting embrace of large- and mega-cap fare, namely tech and communication services stocks.
Those sectors usually aren’t heavily represented in traditional small-cap benchmarks, but some market observers believe that smaller stocks will get their grooves back in 2022. That could support the case for exchange traded funds like the Invesco Russell 2000 Dynamic Multifactor ETF (OMFS).
“From a valuation perspective, the small-cap portion of the market and the value side are trading at or slightly under their fair value estimates. Small value is the least expensive segment as a group, currently trading at 91% of its Morningstar fair value estimate,” says Morningstar analyst Lauren Solberg.
OMFS follows the Russell 2000 Invesco Dynamic Multifactor Index, which is the multi-factor derivative of the famous Russell 2000 Index. The factors included in that index are the standards of value, momentum, quality, low volatility, and size, so the Invesco fund does tap into some of the aforementioned value proposition offered by smaller stocks. OMFS allocates 26.4% of its weight to small-cap value names, according to issuer data.
Speaking of value, Compass Minerals International (NYSE:CMP) and John Wiley & Sons (NYSE:JW.A) are among the OMFS holdings that Morningstar highlights as undervalued small-cap names.
“At current prices, we view Compass’ shares as undervalued, with the stock trading nearly 35% below our fair value estimate. While the stock is no longer appropriate for dividend investors, we continue to see long-term profit growth for Compass,” says Morningstar analyst Seth Goldstein.
OMFS further leans into value with a 23% weight to financial services stocks. That’s a potential benefit to investors when considering that the Federal Reserve could raise interest rates multiple times next year and that small-cap financial services names are historically positively correlated to rising rates.
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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.