Alan Abelson on Small-Cap ETFs (IWM, IJR, IWC, PZI)

Alan Abelson's Barron's column Up and Down Wall Street this week contains an interesting chart comparing the assets in the iShares Russell 2000 ETF (ticker: IWM) with the Russell 2000's performance:

Mr Abeson points out that asset inflows into the ETF and the performance of the Russell 2000 have moved in line with each other. He quotes Satya Pradhuman, Merrill Lynch's chief small-cap strategist, who argues that "The popularity of [the ETFs] is symptomatic of the classic small-cap cycle".

He then makes a number of points:

Because the aggregate market cap of the stocks in the Russell 2000 is far smaller than the aggregate market cap of the stocks in the S&P 500, inflows into the small cap ETFs are likely having a disproportionate impact on small cap prices.

Professional money managers are using the ETFs to gain exposure to small cap stocks.

IWM, and to a lesser degree the S&P Small Cap 600 ETF, IJR, are thus highly susceptible to changes in investor sentiment.

This phenomenon might be even more true of the new micro-cap ETFs, IWC and PZI.

The conclusion? The small cap ETFs may be riskier and more volatile than people realize.

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Comments

[hmorgan]

I find the emergence of the two new Microcap ETFs a bit puzzling. On the one hand the two sponsors say "Look at what we have to offer.....liquidity in Micro Caps"
Liqudity is essentially the main barrier to entry for money managers...we don't like to buy things we can't sell...quickly.
So now we are offered the liquidity of ETFs with the asset class characteristics of MicroCaps. But I see a problem.

The problem is that the sponsors (Barclays & Powershares) seem to recognize the illiquidity of the asset class too. Barclays for example has 1/2 of the portfolio in the bottom 1000 securities of their small cap portfolio (Russell 2000 IWM) causing serious overlap. On top of that, they go all the way down to companies with a $50mm market cap.....this could potentially cause extreme price movements in these smallest of companies should investors flock to create or redeem shares.
This may be a classic case of the fund business creating product where demand exists despite the challenges presented by the market place.

Herb Morgan