Small-cap ETFs help to play market trends
Investing in small-cap stocks is a great way to add profitable investments to your portfolio, and investment newsletters like my free SmallCapInvestor Daily or my premium SmallCapInvestor PRO service are a great way to find potential winners.
Some investors like to compliment their individual small cap picks with additional exposure to this class of equities that is known to out-perform during and immediately after a recession. Exchange Traded Funds, or ETFs, are one way you add exposure to small caps without having to concentrate all of your investments in individual stocks. And there are a number of options that small-cap investors should be aware of and have in their potential investment quiver.
ETFs function in a similar way to a mutual fund. A fund manager designs an ETF to follow a certain investment theme – this can be an index, a commodity, or even a sector of the stock market such as retail or technology. The fund holds assets that could include stocks, bonds, currencies, or commodities – whatever is needed to meet the design characteristics of the fund.
One major benefit of this investment vehicle is that you can get broad exposure to a trend, but buy shares in only one fund. And it is just as easy to enter, add to, or exit a position as it is trading shares of a single stock. ETFs have become more popular in recent years among active traders who want to be able to trade in funds intra-day. Unlike mutual funds which can be bought or sold only once a day, ETFs trade throughout the day just like stocks.
There are ETFs that cover the full spectrum of potential investment ideas, but some of my favorites (this should come as no surprise) are those that cover small-cap stocks. The iShares Russell 2000 ETF (NYSE: IWM) is designed to track the performance of the Russell 2000 small-cap index. This index is really the bell-weather for overall small-cap performance and includes companies with a weighted average market cap of $1 billion and an average P/E of 18.2%.
This fund invests at least 90% of assets in companies that are in the index so it provides a mix of both value and growth oriented stocks just like the Russell 2000. To help the fund track the index as accurately as possible, up to 10% of the remaining assets can be invested in options, futures or other investment vehicles.
Another option is the iShares S&P SmallCap 600ETF (NYSE: IJR) which also invests over 90% of assets in the underlying index, in this case the S&P SmallCap 600 index. This fund shares most of the same companies with the IWM and so as a result the performance in the two funds is nearly identical.
If you’re looking to invest only in small-cap growth stocks there is the iShares Russell 2000 Growth Index (NYSE: IWO) or if your are a value investor you’ll want to pick up shares in iShares Russell 2000 Value Index (NYSE: IWN). Both options cover small-cap members of the Russell 2000 but with a particular focus as their respective names imply. The IWO holds companies showing greater growth, whereas the IWN focuses on companies that pay bigger dividends, but trade with lower price-to-book ratios and lower growth. As we would expect the yield on the IWN is much higher, at 2.07% versus that of the IWO which only yields 0.7%.
Of course, if you’re feeling bearish about small-cap stocks you can short the Russell 2000 by buying shares of the ProShares Short Russell 2000 (NYSE: RWM) which will provide a return similar to the inverse of the underlying index. For the truly bearish there are double and triple-short ETFs out there (or double and triple-long, for the super-bull), but be forewarned, these are risky investments and employ leverage to achieve their returns. Since I’m an investor and not a trader, I steer clear of these options and suggest you do the same unless you take the time to read, and understand, the potential pitfalls of leveraged funds. I’ll discuss these in a future issue of this newsletter.
If you’re interested in learning more about these funds I encourage you to visit their websites and read more before investing. Click on the following links for iShares or ProShares and you can get started.
We’ll talk more about how ETFs can help us make money investing in small-cap stocks in future articles, but now I want to let you know about an exciting event that is coming soon, and it’s all about investing in China.
China runs more like a for-profit corporation than most investors want to admit. And while there are always risks, I haven’t sold any of the Chinese stocks I’m holding in the SmallCapInvestor PRO. That’s because I remain bullish on China, Inc.
If you want to find out why – and get a few of my top Chinese stock recommendations – then join me on January 20, at 6 pm ET for a special video investment conference called China Inc.: Understanding China for Outstanding Profits.
This event is completely free for SmallCapInvestor Daily readers. And after just 20 minutes you will walk away with a new perspective on investing in China that will reward you in the months and years to come.
