Are Small Caps Running Out of Steam After Recent Rally?

Equities, small or large, have been rising in unison since the height of the coronavirus pandemic sell-offs back in March. However, as the race to recovery gets longer in the tooth, it could be small caps huffing and puffing as they run out of steam.

“The Russell 2000 small-cap index has underperformed large-cap benchmarks by a country mile in recent years, with big corporations reaping the benefits of the largest tax cut in history,” Alan Farley wrote in an Investopedia article. “At the same time, mega-caps like Alphabet Inc. (GOOGL) and, Inc. (AMZN) have taken control of thousands of market niches previously filled by small businesses, making it nearly impossible for them to compete.”

“It’s not surprising that the iShares Russell 2000 ETF (IWM) posted larger losses than big caps in the first quarter selloff, given those steep headwinds, dropping 44% compared to 30% for the Invesco QQQ Trust (QQQ) and 33% for the SPDR S&P 500 ETF Trust (SPY),” Farley added. “The second quarter bounce has been relatively weak for small caps as well, despite a few rally days that market analysts have attributed to heavy buying by the recently dubbed “Robinhood traders,” also known as young folks who opened free trading accounts with government stimulus checks.”

If investors still believe that strength could be ahead for small caps, one fund to take a look at is the Vanguard Small-Cap Value Index Fund ETF Shares (NYSEArca: VBR). VBR seeks to track the performance of a benchmark index that measures the investment return of small-capitalization value stocks. The fund employs an indexing investment approach designed to track the performance of the CRSP US Small Cap Value Index, a broadly diversified index of value stocks of small U.S. companies.

A Small Cap Fund with a Multi-Factor Approach

In today’s market that’s brimming with uncertainty surrounding the coronavirus outbreak, it can also help investors to use factor investing to filter out the best opportunities. Nowadays, the focus has been quality and value amid the discounted equities, but investors also shouldn’t miss out on other factors like growth or momentum.

Investors looking for small cap exposure using a multi-factor strategy can use the Principal U.S. Small-Cap Multi-Factor Index ETF (PSC). PSC seeks investment results that closely correspond, to the performance of the Nasdaq US Small Cap Select Leaders Index.

The fund invests at least 80% of its net assets, plus any borrowings for investment purposes, in equity securities of companies that compose the index. The index uses a quantitative model designed to identify equity securities (including growth and value stock) of small-capitalization companies in the Nasdaq US Small Cap Index (the “parent index”) that exhibit potential for high degrees of sustainable shareholder yield, pricing power, and strong momentum, while adjusting for liquidity and quality.

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