When it comes to portfolio allocations strategies, for years small-cap equities have found their way into many investors’s portfolios, proving to be a useful and potentially lucrative allocation. The investment thesis behind small caps is that these firms are likely to provide strong growth prospects and should have a much easier time growing than their large-cap counterparts. Although these securities can be extremely volatile, small-cap equities can serve as great diversifying agents since they tend to move somewhat independently of large caps. Additionally, the small capitalization segment of an equity market makes for a better “pure play” on the local economy [see also 3 Surprising A+ ETFs].
For investors looking to gain exposure to small-cap equities, there are a number of popular options, but perhaps the best way to start sifting through the space is to look at the funds that have delivered stellar returns. Below we highlight five small-cap ETFs standouts, whose double-digit returns over the past five years may convince some investors to include them in their portfolios:
1. FTSE RAFI US 1500 Small-Mid Portfolio (PRFZ)
Although not a “pure” small-cap ETF, this fund from PowerShares’ popular RAFI lineup offers exposure to both the mid and small-capitalization segment of the U.S. equities market. Most market cap indexes are linked directly to the stock price of underlying securities, which results in the tendency of these funds to underweight undervalued securities and overweight overvalued stocks. But the RAFI methodology is designed to break the link between stock price and index weight by selecting holdings based on the following four fundamental measures of size: book value, cash flow, sales and dividends. Over the last five years, PRFZ’s methodology has paid off, placing the fund at the top of our list with a five-year return of nearly 23%.
2. SPDR S&P 600 Small Cap ETF (SLY)
Although it may be surprising to find a traditional cap-weighted fund in the mix of these more “sophisticated” products, State Streets’ SLY has certainly shown that it’s worth its salt. The fund’s methodology is quite simple: IJH tracks the S&P SmallCap 600 Index, a benchmark designed to measure the performance of the small capitalization sector of the U.S equities market. Not only is SLY one of the largest ETFs in its category, the plain-vanilla fund has also managed to produce a 20% return over the last five years. Similarly, iShares’ SS&P SmallCap 600 Index Fund (IJR), which tracks the same index, has gained nearly 15% [see also How To Pick The Right ETF Every Time].
3. Small-Cap ETF (VB)
This offering from Vanguard is linked to the MSCI US Small Cap 1750 Index, a benchmark that represents the universe of small capitalization companies in the U.S. equity market. VB is one of the most well-balanced and broadest small-cap ETFs available; it maintains a basket of nearly 1,720 individual securities with no one stock making up more than 30 basis points of total assets. Unlike some of the other offerings on this list, VB nicely spreads out allocations across multiple sectors, featuring exposure to industrials, technology, consumer cyclicals, financial services and many other sectors. The fund also features one of the lowest expense ratios in its category, coming in at a mere 0.16%. Over the last five years, holders of VB have enjoyed an over 15% return.
4. Small Cap Core AlphaDEX Fund (FYX)
This fund comes out of the First Trust’s popular lineup of AlphaDEX funds. The benchmark underlying FYX is an “enhanced” index that employs the proprietary AlphaDEX methodology to select stocks from the S&P SmallCap 600 Index. The selection process is designed to either minimize exposure to, or completely eliminate, the least promising stocks from the index. The AlphaDEX methodology has proven its potential to outperform other traditional small-cap weighted indexes, as FYX has gained nearly 15% over the last five years [see also AlphaDEX ETFdb Portfolio].
5. Morningstar Small Core Index Fund (JKJ)
iShares’ JKG focuses its attention on small-cap stocks that exhibit “average” growth and value characteristics. The resulting portfolio is well-balanced with each of its over 250 individual securities receiving a weighting of no greater than 1%. JKJ also features exposure to a number of sectors, but has a slight tilt towards industrials and consumer cyclicals. Over the last five years, JKG has provided a nice 9% return for its investors.
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