Tilt Toward the Night to Enhance Small Cap Performance | ETF Trends

While increased volatility is inherent to small caps, advisors can enhance small-cap performance by capturing the night effect.

The overnight trading session has delivered much of U.S. large and small cap equities’ return with much lower volatility than the day session over the past 20 years. This phenomenon is referred to as the night effect, whereby equities have historically performed better during the overnight session (when local markets are closed) than during the day when markets are open.

While the phenomenon is observed across the cap spectrum, the power of the night effect is even more pronounced in small caps. Notably, over the past 20 years (2003 through 2022), 100% of the returns generated by the iShares Russell 2000 ETF (IWM) have come at night.

“In small caps, it really just pays to avoid the day,” NightShares CEO Bruce Lavine said on February 21 during How the Night Effect Can Benefit Your Portfolio.

Looking at the past 20-year record (2003 through 2020), the IWM Sharpe ratio is 0.46 for holding the ETF. During the same period, the night session Sharpe ratio is 0.90, while the day session Sharpe ratio is -0.08. The day session Sharpe ratio is negative as the session’s returns over the 20-year period have been negative, as over 100% of the fund’s returns have come at night.

Lavine and the team at NightShares launched three ETFs in 2022, offering investors the ability to efficiently capture the night effect for the first time, something previously only accessible on an institutional trading floor or at a hedge fund. The NightShares 2000 ETF (NIWM) provides exposure to the night performance of 2000 small-cap U.S. companies.

As advisors consider investing in the night effect to enhance performance for clients, Lavine said he recommends starting by tilting toward the night without getting out of the day.

“Let’s say the advisor comes up with maybe 20% of the U.S. equity allocation is small cap. We can obviously make a case for all of that going into a NightShares ETF, but that’s not realistic because the night effect does not work all the time,” Lavine said. “So we will tell advisors to maybe start out with 20% to 30% of the small-cap allocation to the NightShares ETF. What you’re essentially doing is tilting towards the night but not getting out of the day in that case.”

For more news, information, and analysis, visit the Night Effect Channel.