Small Cap Value ETFs: Should You Invest and How?

 |  Includes: IJS, IWM, IWN, SPY, VBR
by: MyPlanIQ

Small company stocks have been long regarded as one of few classes that offer opportunities to exploit market inefficiency. Value small cap stocks add another return factor to beat general market indices as exhibited by performance of many value oriented stock funds, exemplified by Buffett and Sequoia Capital.

The following table compares performance among Russell 2000 (NYSEARCA:IWM), Russell 2000 Value (NYSEARCA:IWN) and SPDR S&P 500 (NYSEARCA:SPY) (7/31/2001 is the inception date of IWN):

Portfolio Performance Comparison

Portfolio/Fund Name 1Yr AR 1Yr Sharpe 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe Since 7/31/2001
IWN 15% 82% 4% 10% 2% 0% 8.5%
IWM 19% 101% 3% 11% 3% 5% 5.1%
SPY 16% 133% -0% -0% 2% 4% 2.2%
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From the above, small value outperforms small cap while large cap dominated SPY fares the worst. For more detailed performance comparison, refer here.

Let's take a closer look at small cap value ETFs. The Russell 2000 Value (IWN) has the longest history. It uses a sampling strategy to track the Russell 2000 index, which consists of 2,000 of the smallest capitalization-weighted companies included within Russell's broader 3000 index. It has an expense ratio of 0.20%.

If you're looking to track a slightly different small cap benchmark, try the Vanguard Small Cap ETF (NYSEARCA:VBR). This fund tracks the MSCI US Small Cap 1750 index, which represents about 11% of the total U.S. equity market and counts Kansas City Southern (NYSE:KSU) and DeVry (NYSE:DV) among its top holdings. This particular index can perform quite differently from the Russell 2000 at times, and it tends to be a bit more volatile. Please see the one year sharpe ratio of one year in the below table. Therefore, expect this fund to experience more swings in returns from year to year. But the fund's low 0.10% expense ratio is hard to beat.

The following table compares the small cap value ETFs:

U.S. Small Cap Value 06/10/2011

Description Symbol 1 Yr 3 Yr 5 Yr Avg. Volume(NYSE:K) 1 Yr Sharpe
Vanguard Small Cap Value ETF VBR 19.65% 3.55% 2.79% 107 106.37%
iShares S&P SmallCap 600 Value IJS 17.63% 2.49% 1.86% 111 87.96%
iShares Russell 2000 Value Ind IWN 19.07% 3.2% 1.56% 1,815 95.16%
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Vanguard ETF VBR again offers the best 1 and 3 year performance. The only drawback is its relatively low trading volume. However, we expect this will eventually change if the outperformance continues.

For information on more ETF performance, please refer to here.

Small cap ETFs has rewarded investors since they were introduced to public. However investors should be aware that such outperformance is not guaranteed. The best way is to adopt diversification approach and/or an systematic active style rotation approach in asset allocation.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: MyPlanIQ does not have any business relationship with the company or companies mentioned in this article. It does not set up their retirement plans. The performance data of portfolios mentioned above are obtained through historical simulation and are hypothetical