In recent weeks, small cap equities have been keeping pace their large cap brethren, but before advisors start sticking their clients into these small cap funds, they might want to think twice. While it helps to diversify a client’s portfolio and get the additional upside of small caps, advisors should keep quality in mind.
Getting quality exposure to small caps is where ETFs like the Invesco S&P SmallCap Quality ETF (XSHQ) come into play. XSHQ seeks to track the investment results of the S&P SmallCap 600® Quality Index.
The fund generally will invest at least 90% of its total assets in the securities that comprise the underlying index. S&P DJI weights each component stock of the underlying index by the total of its quality score multiplied by its market capitalization; stocks with higher scores receive relatively greater weights.
“We definitely like … small- and mid-cap stocks to round out client portfolios from a diversification standpoint, but you have to look under the hood,” said John Petrides, a portfolio manager at Tocqueville Asset Management, according to a CNBC article.
While small caps can still provide the growth-fueled formula that helped to accelerate the decade-long bull run before the Covid-19 pandemic threw a wrench into those plans, advisors should tread lightly before putting client capital into these funds. This is especially the case now with a lot of market uncertainty still lingering with the pandemic and a forthcoming U.S. presidential election.
That said, where do small caps go from here? Of course, it always depends on who you ask and market timing, as expected, is a futile effort for most.
One take is to sell into the recent small cap rally.
“I would look at selling into this recent rally in small caps,” said Mark Newton, president and founder of Newton Advisors, in the same CNBC article.
“It’s always interesting to try to think that you’ve found the bottom, but if you look at just charts, for example, like [the iShares Russell 2000 ETF (IWM )] versus S&P, you see that really, we’ve been in a giant range over the last six months and we’re up to near the highs of this range, so, [it’s] very difficult to make any claims of any sort of breakout, per se,” Newton added.
Of course, the other way to go is to buy into small caps with quality in mind. As such, keep XSHQ on the watch list.