Putting Factors to Work With Small Caps | ETF Trends

With some market observers wagering that small caps are poised to take the lead from their large-cap brethren, putting factors on their side with ETFs, such as the  Principal U.S. Small-Cap Multi-Factor Index ETF (NASDAQ: PSC), could be a winning strategy.

PSC’s underlying benchmark, the Nasdaq US Small Cap Select Leaders 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,” according to Principal.

Wells Fargo is among the banks saying smaller stocks are due for some near-term upside.

“Equity strategist Christopher Harvey said in a note published Wednesday that he upgraded small-cap stock to an overweight rating given their multiyear underperformance, the favorable credit market outlook and a more optimistic macroeconomic outlook as more business reopen,” reports Thomas Franck for CNBC.

Small Caps Make Sense Now

While investors may flock to the relative safety of large cap equities during a recession to lessen the blow of market volatility and to provide a cushion during a market downturn, small cap performance is worth watching as the economy exits a recession. As such, investors may want to give small cap equity funds a look now and make a value-oriented play relative to their potential gains.

Historically, the small-cap/value combination has been rewarding, but it took a big hit when value languished during the recently deceased bull market. The tendency of factor leadership to change from year to year underscores PSC’s utility: with the Principal ETF’s multi-factor approach, investors don’t incur the burden of factor timing.

Looking back at historical data, it’s been the large-cap companies that have absorbed the majority of the blow during a crisis, but when it comes to searching for value-infused plays in the market, small caps offer investors an option worth considering.

Wells Fargo’s Harvey “added that unprecedented actions take by the Federal Reserve to support small business lending will also provide the hard-hit small-cap stocks with a meaningful backstop from which to stage a comeback in the second half of 2020,” according to CNBC.

PSC is higher by more than 10% over the past month.

For more on multi-factor strategies, visit our Multi-Factor 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.