Small-cap stocks and the corresponding exchange traded funds are delivering for investors. That includes some smart beta strategies, such as the WisdomTree SmallCap Earnings Fund (NYSEArca: EES).
EES, which weights its components by earnings, is up more than 9% year-to-date. The fund is one of several earnings-weighted products from WisdomTree, which also offers the WisdomTree Total Earnings Fund ETF (NYSEArca: EXT) and WisdomTree Earnings 500 Fund (NYSEArca: EPS), among others.
Specifically, the ETFs track earnings-weighted indices that screen for positive cumulative earnings over their most recent four fiscal quarter period and assigns weights to components to reflect the proportionate share of the aggregate learning’s each company generated, so those with greater earnings have larger weights. Due to this particular indexing methodology, the ETFs lean toward value and quality factors, and within the mid- and small-cap ETFs, the size factor, which have all been historically associated with excess returns compared to the broader market over the long-haul.
EES can be alternative to traditional, diversified small-cap ETFs, which may track benchmarks chock full of richly valued growth stocks from the healthcare and technology sectors.
“If we drill down into those health care and biotech companies, we notice that roughly 62% of them generate no profits, so betting on the Russell 2000 requires that investors assume this embedded speculative bet. For those looking for an alternative, WisdomTree believes you can increase quality and reduce valuation risk by limiting your small-cap exposure to only companies that generated profits in the prior fiscal year,” said WisdomTree in a recent note.
Examining EES
EES, which is 11 and a half years old, has nearly $737 million in assets under management and holds over 800 stocks. Financial services and consumer discretionary names combine for about 40% of the fund’s weight while industrial and technology stocks combine for almost a third.
Academic research, notably the Fama and French Three Factor Model, and historic data have shown that smaller companies typically outperformed larger companies over time as more nimble, smaller businesses have more room to quickly expand. Additionally, many argued that there are inefficiencies in the market as investors mispriced the value factor, which leaves these types of companies open to outperform over the long-term.
“Over the 10-year time frame, it has generated returns that have surpassed the Russell 2000 by approximately 300 bps on an annualized basis,” according to WisdomTree.
For more information on factor-based investments, visit our smart beta category.