Micro-caps, the group of stocks with lower market values than small-caps, can be a tricky segment. Within the micro-cap realm, there are opportunities to generate significant upside while potentially outperforming other market cap segments, but stock picking in this arena is difficult.

Enter the iShares Micro-Cap ETF (NYSEArca: IWC), which is higher by almost 15% year-to-date. IWC follows the Russell Microcap Index.

Micro-cap companies have a market capitalization of around $50 million and $300 million, or less than small-cap stocks. Typically, investors will notice that larger capitalization stocks are less risky, generating smaller but more steady returns. In comparison, smaller company stock sees greater swings, but the added risk comes with potentially greater returns.

Micro-caps offer “low correlations with the upper reaches of the market-cap ladder. It might also serve as a more liquid, less costly, and more readily accessible proxy for a private equity allocation,” said Morningstar in a recent note. “However, this asset class is not without its drawbacks. Chief among these are greater volatility and limited liquidity and capacity. Also, for fund investors, there are few options for exposure to this sliver of the market. It is a market segment where indexing is challenged. Fortunately, there are some better alternatives.”

Inside IWC

The $836.6 million IWC, which turned 14 years old in August, holds almost 1,400 stocks and has a three-year standard deviation of 17.66%.

Small-caps are focused on the domestic economy and have less direct exposure to global geopolitical uncertainty and currency risks, as opposed to large-cap companies that have an international footprint, which may be affected by overseas risks and a strengthening U.S. dollar.

“Micro-cap stocks tend to be riskier than small-, mid-, and large-cap stocks. Smaller companies tend to be riskier. They often have weaker balance sheets, more limited product, and service offerings, limited geographic diversification, and less experienced managements than larger companies,” according to Morningstar.

Related: 3 ETFs to Capture a Resurgence in Small Cap Equities

IWC allocates nearly half its weight to financial services and healthcare stocks.

“Most notably, micro-caps have some diversification potential. This is evidenced by the fact that they are not perfectly correlated to other segments of the U.S. market-cap spectrum,” notes Morningstar.

For more information on the small capitalization segment, visit our small-cap category.

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.

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