Small-Cap Value ETFs: The Right Play Now?

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Includes: DES, IJS, VBR
by: Zacks Funds

The ominous clouds that have been hanging over the U.S. small-cap ETFs space since the start of the year seem to be dispersing now. The space came under pressure at the beginning of 2016 due to a raft of downbeat U.S. economic readings, weaker greenback and risk-off trade sentiments in the market (owing to global growth worries as well as oil price turmoil) and threw U.S. small-cap ETFs out of investors' favor.

However, things are turning around lately with a volley of improving U.S. economic data, be it labor market, retail and manufacturing. Though the Fed reduced its forecasts for rate hikes in 2016 from four to just two hikes, a few hawkish comments from some Fed officials revived the rate hike talks.

As per these officials, the reduced rate hike projection mainly reflected the tantrums thrown by the global financial market, which are now showing signs of cooling off. The two important indicators to measure the timing of another rate hike - labor market and inflation - are both stabilizing.

San Francisco Fed president even said that he would promote a hike as early as April. Meanwhile, Q4 2015 U.S. GDP was adjusted higher, from the advanced estimate of 0.7% to 1.0% in the second estimate and then finally to 1.4% in the third reading.

This is the reason that small-cap stocks could arguably be better plays in today's economy. Small caps perform better when the domestic economy is marching higher as these pint-sized stocks generate most of their revenues from the domestic market, turning out to be safer bets than their large and mid-cap cousins. As these are less exposed to foreign markets, these stocks remain less scathed by the stronger greenback.

Having said this, we would like to note that uncertainties in the economy still persist. The latest data which showed that the U.S. consumer spending grew slightly in February and overall inflation moved back gave us some reasons to doubt the possibility of an April rate hike.

Also, small caps normally experience higher levels of volatility. That is why investors intending to bet on small-cap ETFs may also need some amount of safety or value quotient in their portfolio. This strategy may prove fruitful for investors as the chances of the market going wild are higher next month.

Analysts noted that, "during the periods when the Fed was raising interest rates, the value stocks had an average return of 1.2% a month, or 14.4% a year, versus the growth index's 0.7% a month, or 8.3% a year."

Below we highlight three such ETFs which could be in focus in the coming days.

SmallCap Dividend Fund (NYSEARCA:DES)

DES looks to track the performance of the WisdomTree SmallCap Dividend Index. The fund is one of the popular choices in the small-cap value space with about $1.17 billion in AUM. It charges 38 bps in fees.

Holding more than 700 stocks in its basket, the product puts about 10% of its total assets in the top 10 holdings, suggesting low concentration risk. Sector wise, this ETF is heavy on financials (24.6%) followed by consumer discretionary (18.3%), industrials (16.5%) and utilities (10.0%).

The fund has a yield of 2.94% per annum. The fund carries a Medium risk outlook along with a Zacks ETF Rank #3 (Hold).

Vanguard Small-Cap Value ETF (NYSEARCA:VBR)

This fund provides exposure to the value segment of the U.S. small cap market by tracking the CRSP US Small Cap Value Index. It holds a large basket of 856 stocks, which is widely spread across individual securities as none of these has more than 0.6% of assets.

In terms of sector exposure, financials dominates the portfolio at 30.4%, followed by industrials (20.2%) and consumer services (12.2%). The ETF is quite popular with AUM of more than $6.01 billion. It charges 9 bps in fees per year from investors.

The fund has a dividend yield of 2.30% (as of March 28, 2016). VBR has a Zacks ETF Rank #3 with a Medium risk outlook.

S&P Small Cap 600 Value Index Fund (NYSEARCA:IJS)

The fund looks to provide exposure to U.S. small-cap value stocks by tracking the S&P SmallCap 600 Value Index. The $3.23-billion fund holds a total of 453 small cap stocks. The fund appears diversified as no stock accounts for more than 1.07% of the basket. Among the different sectors, Financials, Industrials, Consumer Discretionary and IT occupy the top four positions with 21.7%, 18.9%, 16.4% and 16% of weight, respectively. The fund charges a premium of 25 basis points annually. This Zacks Rank #3 ETF yields 1.52% annually (as of March 28, 2016).

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