Likely to the chagrin of frustrated investors, the Russell 2000 Index is only modestly higher since the Federal Reserve lowered interest rates. That confirms that patience will be required in order to realize big gains with smaller stocks.
Investors can alleviate some of that burden with ETFs such as the Neuberger Berman Small-Mid Cap ETF (NBSM ). As its name implies, NBSM is small/midcap (SMID) blend fund so it’s not dependent on either segment to drive returns. The inclusion of midcaps, which admittedly haven’t set the world ablaze since the aforementioned rate cut, is potentially attractive for advisors and investors. Midcaps have historically featured lower volatility than their smaller counterparts, often with superior return profiles.
Another potential perk associated with NBSM is its status as an actively managed fund. That’s a potentially compelling trait in a corner of the equity market where active management can be advantageous.
“The relative lack of analyst coverage in the SMID-cap universe can result in companies that are underappreciated and mispriced versus their potential, creating opportunity for active managers to add value,” according to NBSM’s issuer.
Speaking of Active Management…
Applying active management to the SMID space isn’t just about unearthing hidden gems Wall Street is ignoring. That management style can be impactful by steering towards quality and away fundamentally flawed firms. Those objectives are difficult to accomplish with some broad-based small-cap indexes.
“Roughly half the companies on the Russell 2000 aren’t profitable, which means they’re often highly leveraged. Lower rates help reduce their interest expenses, since smaller companies rely more on variable financing,” reported The Daily Upside.
So while rate cuts could benefit smaller stocks, investors can reduce dependence on Fed assistance by embracing NBSM. It’s emphasis on quality can create a portfolio that’s not littered with indebted, rate-sensitive companies.
In fact, NBSM is significantly underweight the healthcare sector, which in smaller stock terms is often dependent on low borrowing costs. Conversely, the ETF is significantly overweight industrial stocks relative to the Russell 2000. That indicates that the fund could have some positive correlation to rising defense and infrastructure spending.
Still, it’s hard to knock the potential potency rate cuts can have for smaller stocks. With that in mind, NBSM could be primed for upside, meaning patient investors could be rewarded.
“Bloomberg compiled analysts’ price targets for the index last week and, with the expectation of rate cuts, Wall Street sees the small cap index rising as much as 20% in the next 12 months, better than the 11% envisioned for the S&P 500,” according to The Daily Upside.
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