Investors often hear about passive investing’s dominance in the ETF world and markets writ large. With about 84% of small and mid-cap ETF assets in passive strategies, for example, it’s hard to avoid their sheer size. Of course, size isn’t everything, especially as small-cap indexes are weakening over time. That long-term issue may point to an active small-cap ETF approach instead.
See more: This Trio of Active ETFs Sending Buy Signals
Why are small-cap indexes losing their luster? With investment strategies, little matters as much as information does – and it’s information quality that they’re losing.
As the number of public companies dropped from over 7,000 in 1998 to less than 4,000 today, small-cap indexes have worsened. A study by Furey Research Partners, as cited by T. Rowe Price, indicates that the median return on investment on the Russell 2000 index has dropped from 12.6% to 6.4% in that time frame.
An Active Small-Cap ETF to Watch
Add in the relatively larger inefficiencies in small caps relative to large-cap firms, and the case for an active small-cap ETF grows. The T. Rowe Price Small-Mid Cap ETF (TMSL ) presents a strong alternative to passive small-cap strategies. The ETF charges only 55 basis points (bps) for its active approach.
A core small- and mid-cap blended strategy that can span across growth and value styles as needed, considering individual stocks based on factors like stability, relative valuation, earnings quality, and more. Smaller companies historically provide significant growth potential. Broadening the scope to also include some mid-cap exposure can help improve stability and widen the opportunity set. In doing so, the ETF has returned 5.9% over the last three months. The strategy outperformed its ETF Database Category and Factset Segment averages at that time.
With rate cuts still potentially in the cards, small firms could benefit. Active strategies like TMSL present one option to identify such firms. Where small-cap indexes are losing information quality, experienced managers and their bottom-up analyses could help an active small-cap strategy like TMSL stand out for the rest of the year.
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