This Small-Cap ETF Rally Could Prove Durable | ETF Trends

The Principal U.S. Small-Cap Multi-Factor Index ETF (NASDAQ: PSC) is higher by more than 5% over the past month and that could be the start of something more substantive as factor-based small-cap strategies gain momentum.

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.

Traditionally, small-cap value has been a winning combination, but as is the case with large caps, growth is winning the day with smaller stocks. That’s relevant regarding PSC because the fund is a multi-factor ETF, not a dedicated strategy.

Momentum Matters

Rather than harping on value, which has been a laggard factor for over a decade, PSC tilts toward momentum, among other factors. The pairing of small-cap momentum can be a winning combination for investors.

Momentum investing is rooted in the notion that securities that are on torrid paces will continue acting that way over the near-term while laggards will continue slumping. Long-term data for the momentum factor are compelling, but the factor can be volatile. PSC mitigates some of that turbulence by introducing shareholder yield to the equation, a strategy that adds a dash of quality to the portfolio.

In this case, momentum is referring to the rate of acceleration of a security’s price or volume—that is, the speed at which the price is changing. Once a momentum trader sees acceleration in a stock’s price, earnings, or revenues, the trader will often take a long or short position in the stock in the hope that its momentum will continue.

Additionally, momentum investing can target those companies that are exhibiting high levels of growth. The momentum factor selects company stocks that have recently outperformed based on the idea that “the trend is your friend” and that stock market leaders typically continue to outperform. This type of strategy can be an effective way of targeting growth-oriented companies since stocks with positive momentum often continue to generate strong earnings.

Indeed, PSC has momentum on its side as the Principal ETF allocates over 34% of its combined weight to the healthcare and consumer discretionary sectors, which are among the best-performing groups this year in the small-cap space.

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.