ETF Trends
ETF Trends

It took a while for U.S. small caps and the related exchange traded funds to get going in 2017, but the group is ending the year on a strong note. An idea among smart beta small-cap ETFs to consider in 2018 is the JPMorgan Diversified Return U.S. Small Cap Equity ETF (NYSEArca: JPSE).

JPSE reflects the performance of the Russell 2000 Diversified Factor Index, which is comprised of small-cap equity securities in the U.S. selected based on a rules-based proprietary multi-factor selection process that screens for relative valuation, momentum and quality. Stocks are also weighted to diversify risk across individual equity securities. According to J.P. Morgan, this process has historically helped drive strong performance.

While JPSE is a multi-factor ETF, one of the investment factors it taps is the value factor. Small caps and value have historically been a potent combination. The outperformance may be attributed to the small-cap, value-oriented ETFs’ tilt toward favorable sectors in the current market environment. Specifically, financials and industry, two outperforming sectors in recent weeks, make up a large portion of the funds’ underlying holdings.

“The approach is working. Year-to-date, JPSE is up about 13%, an advantage of nearly 100 basis points over the Russell 2000 Index. Additionally, JPSE is outperforming the Russell 2000 Value Index by a better than 2-to-1 margin. JPSE is also outperforming the S&P SmallCap 600 Index this year,” according to Investopedia.

Moreover, the fund’s screen process should help diminish risk or exposure to more volatility small-cap securities to help bolster long-term, risk-adjusted returns. The underlying index diversify risks that are less likely to be rewarded while overweighting areas that are more likely to be rewarded.

“The ETF’s multi-factor approach is bearing fruit. After all, U.S. small-caps are lagging large-caps and the value factor is trailing other factors, indicating JPSE’s integration of quality and momentum into the small-cap value equation is compelling for long-term investor,” reports Investopedia.

The alternative multi-factor indexing methodology may help investors diversify away from potential risks associated with traditional market capitalization-weighted indices, such as bubbles, risk concentrations and preference for overvalued stocks.

For more on smart beta ETFs, visit our Smart Beta Channel.