Small-capitalization stock investors were defensive going into the 2017, but they have quickly changed their tune, turning to more growth-weighted smaller company picks. Investors can also gain diversified exposure to the small-cap growth style through related exchange traded funds.
Investors largely favored value and defensive styles, or “risk-off” investments, in the fourth quarter of 2016 but have since flip-flopped to the growth style, according to a recent FTSE Russell research note.
“A very different sentiment emerged as we entered 2017. There was a dramatic shift to what is considered a more “risk-on” approach as value and defensive styles were traded out for growth and dynamic…. this trend has continued through the second quarter of 2017,” according to FTSE Russell.
The shift is partly attributed to the below average volatility in the small-cap category as low volatility typically provides market participants more confidence about the stability of a certain market segment. Looking at the CBOE Russell 2000 Volatility Index, the gauge of small-cap volatility showed a maximum level of 20 in the second quarter, compared to its ten-year average of 26.
“In view of the big style shift within the US small cap universe from a risk-off to a risk-on stance, it seems market participants are feeling more confident in the strength of the US economy,” according to FTSE Russell. “This sentiment has been mirrored by the Federal Reserve’s moves to raise rates and wind down the quantitative easing programs established during the Financial Crisis in 2008.”
Related: A Reversal of Fortunes: Sizing Up 2017 ETFs
Investors who believe this risk-on trend will persist as the equity bull market rally will extend can look to growth-oriented small-cap ETFs to gain diversified exposure to this asset category, such as the iShares Russell 2000 Growth ETF (NYSEArca: IWO), Vanguard Small-Cap Growth ETF (NYSEArca: VBK) and iShares S&P Small-Cap 600 Growth ETF (NYSEArca: IJT).
IWO tries to reflect the performance of the Russell 2000 Growth Index, which is comprised of companies with higher price-to-book ratios and higher forecasted growth relative to all issuers in the Russell 2000 Index. The ETF includes a hefty 24.8% tilt toward health care, followed by 24.7% information technology and 17.4% industrials.
VBK tries to reflect the performance of the CRSP US Small Cap Growth Index. The Vanguard option takes a larger tilt toward financials 20.8%, followed by industrials 19.9% and technology 16.7%.
Lastly, IJT tries to reflect the performance of the S&P SmallCap 600 Growth Index, which includes companies with the strongest growth characteristic taken from the S&P SmallCap 600. Top sector weights include industrials 18.8%, information technology 18.1% and health care 15.9%.