PowerShares launched nine highly anticipated new ETF products on Wednesday, introducing a line of funds that offer a new twist on traditional sector-specific investing. The nine PowerShares S&P SmallCap Sector Portfolios are based upon respective S&P SmallCap 600 Capped Sector Indexes, each of which is designed to measure the overall performance of common stocks of a respective sector. The new ETFs include:
- S&P SmallCap Consumer Discretionary Portfolio (XLYS)
- S&P SmallCap Consumer Staples Portfolio (XLPS)
- S&P SmallCap Energy Portfolio (XLES)
- S&P SmallCap Financials Portfolio (NYSEARCA:XLFS)
- S&P SmallCap Health Care Portfolio (XLVS)
- S&P SmallCap Industrials Portfolio (XLIS)
- S&P SmallCap Information Technology Portfolio (XLKS)
- S&P SmallCap Materials Portfolio (XLBS)
- S&P SmallCap Utilities Portfolio (XLUS)
If the ticker symbols look familiar, that’s because PowerShares added an “S” (as in “SmallCap”) to the tickers for each of the existing sector SPDRs. Similar to these popular ETFs from State Street, each of the new PowerShares ETFs will focus on stocks in a particular industry. While the sector SPDRs are based on sub-indexes of the S&P 500, the indexes underlying the new PowerShares funds will divvy up the S&P SmallCap 600 Index. So just as the risk profiles of the S&P 500 SPDR (NYSEARCA:SPY) and the S&P SmallCap 600 Index Fund (NYSEARCA:IJR) are very different, the exposure offered by the new ETFs will be unique from the large cap sector-specific funds currently on the market.
Small Cap vs. Large Cap
The new sector-specific small cap ETFs are exciting for a number of reasons (they were included in the Seven Most Anticipated New ETFs of 2010). First, there’s a mountain of evidence suggesting that over the long-term, small cap stocks tend to outperform large cap stocks. This has especially held true in post-recessionary periods, as a number of studies have shown that small caps have beaten their large cap counterparts following economic downturns by a wide margin. One such study from T. Rowe Price showed that in the 12 month period following nine recent recessions, small cap stocks gained on average 24%, compared to a 17.6% gain for the S&P 500. This has played out over the last year; IJR has outgained SPY by about 28% since the bear market lows hit in March 2009.
“We take great pride in being a leading ETF innovator, and are pleased to introduce a unique suite of small-cap sector portfolios that offer investors access to a vibrant portion of the U.S. equity universe,” said Ben Fulton, Invesco PowerShares managing director of global ETFs. “Over the long term, small-cap companies have outperformed large caps with much of this outperformance occurring during post-recessionary periods. We believe the PowerShares S&P SmallCap Sector Portfolios provide investors a compelling new way to implement sector-based strategies using the beneficial ETF structure.”
Another potentially attractive feature of small cap sector funds relates to the tendency of large cap funds to establish significant concentrations in a handful of companies. The Energy Select Sector SPDR (NYSEARCA:XLE), for example, allocates about 30% of its assets to Exxon Mobil and Chevron. By comparison, the largest two components of the SmallCap Energy Portfolio will account for about 20% of total assets. So the issue isn’t completely eliminated, but the extent of concentration in a handful of names is reduced considerably.
Each of the nine ETFs will charge an expense ratio of 0.29%, putting all of them below the average for their respective ETFdb Categories.
One interesting note on the line of small cap funds; on the recommendation of the S&P team, telecom components of the S&P SmallCap 600 Index were included within the utilities sub-index (it turns out that the performance of telecom stocks lines up closely with performance of utilities). So about 20% of XLUS consists of telecom stocks. Telecom stocks have historically been lumped in with technology funds; telecom components of the S&P 500 are found in the Technology Select Sector SPDR (NYSEARCA:XLK).
Not Better, But Certainly Different
Of course small caps won’t always beat large caps, and any extra return generated will generally come at a price (i.e., greater risk and volatility). The new PowerShares ETFs are exciting products, but that doesn’t mean they’re universally better than the existing sector SPDRs. As discussed above, these products will have different risk/return profiles and will most certainly offer unique exposure. For certain investors and objectives, large caps will be the preferred means of achieving sector-specific exposure, while for others it will be small-caps.
But one thing is certain: investors now have another option for sector-specific exposure in ETF form. And that’s certainly a positive development.
Disclosure: No positions at time of writing.