Big Potential in Small-Cap Wide Moat Stocks | ETF Trends

Due in part to the popularity and the success of the VanEck Morningstar Wide Moat ETF (MOAT) and perhaps owing to investors’ market capitalization biases, wide moat stocks are most frequently associated with large-cap territory.

Those biases belie opportunity in the small/mid-cap wide moat arena — a space made more accessible thanks to the VanEck Morningstar SMID Moat ETF (CBOE: SMOT). The VanEck exchange traded fund, which tracks the Morningstar® US Small-Mid Cap Moat Focus Index, could be a compelling choice for investors looking to add much-needed diversity to portfolios heavy on large-caps.

Additionally, SMOT, which debuted last October, could be right for the current macroeconomic environment, as some market observers believe that smaller stocks are primed for leadership over the course of this year.

“Fading inflation, resilient growth, and a return of cyclicality has finally led US small cap equities to make a big splash on its year-to-date performance. We think this clearer US macro backdrop has presented a path for earnings and valuation to recover more swiftly for smaller US companies relative to larger ones. Still, with recession risk unresolved, we believe active selectivity remains paramount for investors re-establishing strategic weights while going down-in-cap,” according to Goldman Sachs Asset Management (GSAM).

SMOT lives up to its billing as a small/mid blend fund, as the weighted average market capitalization of its 101 components was $16.7 billion at the end of February, according to issuer data.

On a related note, the VanEck ETF is easily outpacing the S&P MidCap 400 Index this year while sporting better than double the year-to-date returns of the S&P SmallCap 600 Index. Add to that, SMOT might have some interesting history on its side.

“Prior periods of high and falling inflation have delivered a 5pp return boost to US small caps relative to US large caps, leading us to believe that this move down-in-cap may further extend. Even so, micro features may usurp macro conditions as key drivers of performance, potentially benefiting small companies with big brands, durable business models, and distinct growth engines,” added GSAM.

Another benefit of SMOT is that its weight to the financial services sector is just 11.33% — a pertinent trait at a time when many investors are worried about the health of mid-sized and smaller banks. Three sectors — consumer discretionary, industrials, and technology — command larger percentages of the ETF’s roster.

Plus, with the Federal Reserve unlikely to cut interest rates this year, SMOT could be all the more appealing as an equity-based play against high Treasury yields.

“We believe this cycle of greater return dispersion and lower stock correlation will likely drive investors down-in-cap and into active management. Historically, stock selectivity has rewarded US small cap managers 1.6x more in annual average excess returns relative to active large cap peers,” concluded GSAM.

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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.