A Smart Idea For Small-Cap Strength

Small-cap stocks and the related exchange traded funds delivered impressive performances last month, a theme that extends to some smart beta strategies. For example, the including the Xtrackers Russell 2000 Comprehensive Factor ETF (NYSEARCA:DESC) gained more than 5% in May.

DESC tracks the Russell 2000 Comprehensive Factor Index. That benchmark “is designed to provide transparent, cost-efficient exposure to small-cap domestic equities based on five factors – Quality, Value, Momentum, Low Volatility and Size,” according to Deutsche Asset Management.

Small-caps, though, can still navigate through a slowly rising rate environment. Smaller companies, which focus on U.S. markets, are less exposed to a stronger U.S. dollar as rates rise, which would more negatively affect larger corporations with a global footprint. Additionally, periods of rising rates also coincide with expanding economies, which often benefit smaller companies.

Multi-Factor Advantages

Over the past few years, money managers and fund sponsors started to roll out rules-based, transparent index ETFs that combined some of the attributes that have historically provided active managers with outperformance, such as prominent investment factors like quality, momentum, value, low volatility and size.

Value stocks typically trade at cheaper prices relative to fundamental measures of value, such as earnings and the book value of assets. Small-cap value has been a winning strategy over the long-term and adding quality and low volatility, among other factors, to that mix as DESC does has the potential to reward investors.

The low-volatility factor, on the other hand, has fallen behind due to concerns over rising rates and the ongoing shift toward growth names. The low-vol factor, though, is now much cheaper on a P/E ratio basis than it was a year ago and relatively cheap when compared to the broader market.