As investors consider small-cap exposure, Joel Schneider, Senior Portfolio Manager and Vice President at Dimensional Fund Advisors, argued that one should also look into a smart beta or factor-based strategy that could potentially enhance returns and diminish potential downside risks.
“Efficiently capturing higher expected returns requires market participants to use the information contained in security prices rationally,” Schneider said.
Specifically, Schneider pointed to four factors that could help drive expected returns, including the equity premium or stocks over bonds; small-cap premium or small company stocks over large company stocks; value premium or value stocks over growth stocks; and profitability premium or stocks of highly profitable companies over stocks of less profitable companies.
“Academic research has shown that stocks characterized by smaller capitalizations, lower valuations, and higher profitability have delivered higher expected returns over time,” Schneider said.
As investors look for a small-cap ETF strategy that incorporates these potential enhancing effects, one may consider something like the John Hancock Multifactor Small Cap ETF (NYSEArca: JHSC). The underlying index is composed of small-cap stocks, excluding those companies with the highest valuations and lowest profitability
The underlying index will also follow a so-called index memory methodology where holdings may be expanded beyond the target range to minimize unnecessary trading and increased expenses. A momentum screen is also included where securities with low momentum do not receive increases to weights during reconstitution.
Financial advisors who are interested in learning more about the small-cap segment or multi-factor strategies can watch the webcast here on demand.