For decades, small-cap value was one of the best factor combinations investors could embrace, but that once royal status has encountered significant challenges in recent years. Still, there’s plenty of potential here, but in an environment that’s not reminiscent of previous eras of small-cap value dominance, investors may want to consider fresher approaches to this factor marriage.
Enter the Principal U.S. Small-Cap Multi-Factor Index ETF (NASDAQ: PSC), which is a multi-factor ETF.
PSC tracks the Nasdaq US Small Cap Select Leaders 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,” according to Principal.
Translation: PSC focuses on quality growth, shareholder yield and price momentum. On a standalone basis, none of those traits are valued per se but combined under the PSC umbrella, those characteristics can give the fund a value tilt.
Why It’s Important
Valuation data suggest now may be an excellent time for investors to revisit small-cap value and consider PSC.
“Over the past couple of years, the gap in P/E ratios between large growth and small value has become bigger than at any time since the early 2000s,” according to Morningstar. “As measured by relative P/E ratios over the past 15 years, small-value stocks look to be somewhat more attractively priced than large-growth stocks.”
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.
There’s a valuation steadiness associated with small value names that often gets overlooked.
“Ratios for small-value stocks have been remarkably steady! The ratios for large-growth companies have ebbed and flowed, partially owing to investor fashion and partially because over time the consensus has been become more enthusiastic about such firms’ business prospects,” according to Morningstar.
The $282.46 million PSC has 464 holdings, about 54% of which hail from the financial services, healthcare, and industrial sectors. Year-to-date, the Principal ETF is beating the CRSP US Small Cap Value Index by about 300 basis points.
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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.