Small cap equities are not to be denied given the latest market rally that is seeing U.S. equities slough off the effects of the coronavirus outbreak. While small caps offer investors the potential for large gains despite more volatility, there is one issue to look out for according to one portfolio manager.

A CNBC report noted the iShares Russell 2000 ETF (NYSEArca: IWM), which tracks the small-cap-heavy Russell 2000 index. It’s been up on the S&P 500 this week at a 4% gain compared to the S&P’s 3.5% gain.

“Valuations are quite attractive [there]compared to their large-cap brethren,” said John Petrides, portfolio manager at Tocqueville Asset Management.

Still, investors shouldn’t be fooled by the numbers and take a closer look under the hood—as the extended bull rally continues to run, investors should be aware of the risks. In this instance, Petrides points to the amount of debt small caps have relative to their larger cap peers.

“I think the biggest issue for small caps, actually, is leverage ratios,” or how much debt a company has versus its equity and capital, Petrides said. “Typically, their balance sheets have more debt relative to large cap. They’re just smaller, so they’re plagued by a law of lower numbers.”

Going Big on Small Caps

For investors looking for continued upside in large cap equities over small caps, the Direxion Russell Large Over Small Cap ETF (NYSEArca: RWLS)offers them the ability to benefit not only from large cap equities potentially performing well, but from their outperformance compared to their small cap brethren.

RWSL features:

  • The Index measures the performance of a portfolio that has 150% long exposure to the Russell 2000® Index (the “Long Component”) and 50% short exposure to the Russell 1000® Index (the “Short Component”).
  • On a monthly basis, the Index will rebalance such that the weight of the Long Component is equal to 150% and the weight of the Short Component is equal to 50% of the Index value.
  • In tracking the Index, the Fund seeks to provide a vehicle for investors looking to efficiently express a small-capitalization over large-capitalization investment view by overweighting exposure to the Long Component and shorting exposure to the Short Component. One cannot directly invest in an index.

On the other side of the coin, for investors looking for continued upside in large cap equities over small caps, the Direxion Russell Large Over Small Cap ETF (NYSEArca: RWLS) offers them the ability to benefit not only from large cap equities potentially performing well, but from their outperformance compared to their small cap brethren.

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