Small Caps The Smart Beta Way

Small-cap stocks and related small-cap ETFs have recently been topping their large-cap rivals in significant fashion. Investors can play that theme with smart beta funds, including the Schwab Fundamental U.S. Small Company ETF (NYSEArca: FNDA).

FNDA is up 8.68% year-to-date. The ETF has a value tilt. Value stocks usually trade at lower prices relative to fundamental measures of value, like earnings and the book value of assets. On the other hand, growth-oriented stocks tend to run at higher valuations since investors expect the rapid growth in those company measures, but more are growing wary of high valuations.

FNDA “offers broad exposure to small-cap U.S. stocks but weights them on fundamental measures of size, including sales (adjusted for leverage), retained operating cash flow, and dividends plus share buybacks, rather than market cap,” said Morningstar in a note out Friday. “This causes the fund to tilt toward stocks trading at low multiples of these metrics and away from stocks trading at higher valuations. However, it does not exclude growth stocks.”

Supporting the small-cap’s recent run up, many traders believed smaller companies were insulated from the overseas turmoil. Furthermore, a stronger U.S. dollar and concerns over weaker global growth are also driving investors toward smaller company stocks that tend to earn most of their money from a still growing domestic economy.

More On FNDA

FNDA holds nearly 900 stocks. The ETF allocates 20.8% of its weight to industrial stocks while the consumer discretionary and financial services sectors combine for almost 31% of its weight. Over the past three years, FNDA slightly trailed the Russell 2000 Index, but the Schwab ETF was also less volatile than the small-cap benchmark.

“From its inception in August 2013 through August 2018, the fund outpaced the Russell 2000 Value Index by 1.39 percentage points annualized. However, it slightly lagged the Russell 2000 Index by 7 basis points annually, owing to a stretch of underperformance in the past year, which stemmed partially from its underweighting of the healthcare sector,” according to Morningstar.

Among smart beta small-cap strategies, FNDA is attractively priced with an annual fee of just 0.25%, or $25 on a $10,000 investment.

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

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.