Small cap stocks experienced a flux of inflows in mid-July as investor rate cut hopes soared. Fidelity offers three actively managed ETFs for investors looking for opportunity in the SMID (small and mid cap) space.
Favorable economic data reflecting a weakening job market and declining inflation raised investor hopes of interest rate cuts beginning in September. Investors rotated from mega-cap technology stocks to small caps on rate cut hopes in mid-July.
Repressed valuations in small caps create rebound potential for the asset class in a more supportive rate environment. “The valuation gap between small caps and large caps has been extreme.” That’s according to Denise Chisholm, Director of Quantitative Market Strategy at Fidelity, in an article earlier this year.
It’s a gap that only widened over the course of the second quarter. Small caps, measured by the Russell 2000 Index, rose just 1.02% on a total return basis year to date as of June 30, 2024, according to Y-Charts. Large caps, as measured by the S&P 500 Index, were up 14.48% over the same period.
An environment of interest rate cuts further supports the outlook for small caps. “Small caps have historically benefited more than large caps from the first rate cut of a cycle,” Chisholm explained. What’s more, “their advantage has been even greater when earnings also improved.”
Mid caps may also prove attractive in the second half. With a risk profile that falls between large and small caps, midcaps offer some of the rebound potential of their smaller peers with less risk. According to Chisholm, they offered a similar valuation to small caps as of May of this year. The S&P 400 hit the cheapest 10% earnings yield of its historical range compared to the S&P 500 earlier this year.
“After similar relative valuation levels in the past, mid-cap stocks outperformed large caps by an average of 15 percentage points over the next 12 months,” wrote Chisholm in May.
SMID Investing With Fidelity
The Fidelity Enhanced Mid Cap ETF (FMDE ) primarily invests in companies within the Russel Midcap Index, while the Fidelity Enhanced Small Cap ETF (FESM ) primarily invests in companies within the Russell 2000 Index. Both Enhanced ETFs are actively managed. They utilize a research driven approach identifying long-term drivers of stock returns, such as growth, valuation, quality, as well as non-traditional factors to evaluate a broad opportunity set of securities. The diversified set of factors helps potentially provide a fuller picture of a securities return potential. FMDE has an expense ratio of 0.23% and FESM carries an expense ratio of 0.28%.
See also: The Potential Benefits of Fidelity’s Enhanced ETF Core Equity Suite
The Fidelity Fundamental Small-Mid Cap ETF (FFSM ) seeks long-term growth of capital. The fund invests primarily in stocks within small and mid cap segments, similar to those within the Russell 2500 Index. The fund invests in growth, value, or both when investing. It uses fundamental factors as well as quantitative analysis to assess the industry position and financial health of individual companies. It also considers market and economic conditions. FFSM has an expense ratio of 0.43%.
For more news, information, and analysis, visit the ETF Investing Channel.
Fidelity Investments® is an independent company unaffiliated with VettaFi LLC (“VettaFi”). These articles do not form any kind of legal partnership, agency affiliation, or similar relationship between VettaFi and Fidelity Investments, nor is such a relationship created or implied by the articles herein. VettaFi LLC is the author and owner of these articles.
