Making the Case for Small Cap ETFs

Includes: IWM, VB
by: Tom Lydon

Small-cap stocks and exchange traded funds have historically led market recoveries. This time around seems no different, and many analysts predict that small-caps are going to be “ones to watch” as the United States dusts itself off.

Louis Basenese for Investment U has these reasons why small-caps will once again lead the markets back to health this year:

  • On average, small-caps outperform their large-cap neighbors for a full three years coming out of a recession, according to Morningstar.
  • Coming off particularly nasty slowdowns, small-caps boast even more endurance. For example, after the 1973-1974 recession, small-caps trounced large-caps for an entire decade, returning an average of 28% per year. [Are small caps really the recovery leaders?]
  • The small size of these shares make them nimble and better equipped to withstand an economy’s ups and downs. Small-caps have a historical tendency to outperform because they’re better able to adapt to shifting market conditions.

Basenese also points out that low-quality stocks – those that suffered the worst beating during the recession – rally first and the most. True to form, financials led the way off the March 9 bottom, rallying an average of 130%.

Get broad exposure to small-caps using ETFs. By doing so, you’ll not only get a wide range of exposure to top companies, but the legwork and research will have been done for you. [Why international small caps may be the ticket.]

  • Vanguard Small-Cap ETF (NYSEARCA:VB)

  • PowerShares FTSE/NASDAQ Small-Cap (PQSC)

  • iShares Russell 2000 Index Fund (NYSEARCA:IWM)