As the equities markets push toward new heights and valuations look pricey, mid- and small-cap investors may turn to a smart beta ETF strategy to add greater value to a diversified portfolio.
The S&P 500 Index and the Russell Top 200 Index have trailing 12-month price-to-earnings ratios of slightly below 22.0x, Christopher Gannatti, Associate Director of Research for WisdomTree, said in a research note. The S&P MidCap 400 and the Russell Midcap Indexes showed P/E ratios of between 24.0 and 25.0x. Meanwhile, the small caps were among most expensive based on price and earnings, with the S&P SmallCap 600 Index trading at about 29.0x and the Russell 2000 Index trading slightly below 50.0x.
Some may question the 50.0x figures for the Russell 2000 Index, but Gannatti pointed out that 20% of companies in the index showed negative earnings, which bring down the earning per share of the full index and leads to a higher P/E ratio. Lower-quality small-caps tend to have high P/E ratios.
Alternatively, investors interested in the mid- and small-cap space but are wary of heightened valuations may consider a smart beta ETF play that specifically focuses on more quality companies, which also provides a greater value tilt. For instance, the WisdomTree MidCap Earnings Fund (NYSEArca: EZM) and WisdomTree SmallCap Earnings Fund (NYSEArca: EES) have outperformed the vast majority of peers in their respective Morningstar categories over the decade-long period they have been active.