IWC Vs. RMT: Comparing An ETF & CEF That Invest In Micro-Cap Stocks
Summary
- My last article compared Micro-Cap IWC ETF against the VOO ETF, which invests in the S&P 500 stocks. The conclusion was there were benefits to owning a combination of them.
- This article takes that idea and compares two Micro-Cap funds that investors could use. There are differences between the funds that could influence that decision on which to own.
- Besides their structural differences, the real decision between these two funds is a matter of whether the investor plans of taking the payouts or reinvesting them. This is covered.
- Looking for more investing ideas like this one? Get them exclusively at Hoya Capital Income Builder. Learn More »
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Introduction
Once an investor decides on a strategy they want to execute, the next step is researching the investment choices available and how they compare. My recent article compared the Vanguard S&P 500 ETF (VOO) against the iShares Micro-Cap ETF (NYSEARCA:IWC), which indicated there are benefits in including both in one’s US equity allocation. Step #2 is then researching options for both parts of that combination. This article will evaluate and compare the IWC ETF against the Royce Micro-Cap Trust (NYSE:RMT), a Closed-End-Fund.
ETFs versus CEFs, a brief overview
Before ETFs started to evolve, there were distinct differences between Exchange-Traded-Funds, or ETFs, and Closed-End-Funds, or CEFs. With the launch of Active ETFs, the passive-ETF versus active-CEF difference isn’t always the case now. While all CEFs do not use leverage to enhance their strategy (RMT doesn’t), I don’t believe ETFs are allowed too. That said, there are leveraged ETFs, but they use derivatives, not borrowings to achieve it. One difference still exists: shares. ETFs make or retire shares as demand changes. Except for unusual events, like COVID, what investor pay closely matches the value of the underlying assets. While CEFs can change the amount of shares outstanding, daily demand doesn’t affect that number, it’s the fund’s decision, not the market’s. As a result, as demand changes, the price investors pay can vary from the Net Asset Value, or NAV. Investors have been able to buy RMT at a discount for over a decade.
Besides their structural differences explained above, the real decision between these two funds is a matter of whether the investor plans of taking the payouts or reinvesting them.
Exploring the iShares Micro-Cap ETF
Seeking Alpha describes this ETF as
The fund is managed by BlackRock Fund Advisors. It invests in public equity markets of the United States. It invests in stocks of companies operating across diversified sectors. The fund invests in growth and value stocks of micro-cap companies. The fund seeks to track the performance of the Russell Microcap Index and was started in 2005.
Source: seekingalpha.com IWC
IWC has $1.2b in assets. The ETF has a low yield of .8% with an expense ratio of 60bps. Russell describes the Index used by IWC as:
The Russell Microcap® Index measures the performance of the microcap segment of the US equity market. Microcap stocks make up less than 2% of the US equity market (by market cap) and consist of the smallest 1,000 securities in the small-cap Russell 2000® Index, plus the next 1,000 smallest eligible securities by market cap. The Russell Microcap Index is constructed to provide a comprehensive and unbiased barometer for the microcap segment trading on national exchanges. The Index is completely reconstituted annually.
Source: research.ftserussell.com
Holdings review
The IWC sector allocations currently are:
Source: seekingalpha.com
I will get into sectors more later but note that Technology ranks only 5th in IWC. That could be important for investors looking to reduce their exposure to that sector. The Top 10 holdings are:
Source: ishares.com IWC
Distribution review
Source: seekingalpha.com DVDs
With a sub 1% yield, the fact payouts vary over time should be a non-issue to investors. IWC earns a "B-" dividend grade from Seeking Alpha.
Exploring the Royce Micro-Cap Trust
Seeking Alpha describes this CEF as
Royce Micro-Cap Trust, Inc. is a closed-ended equity mutual fund launched and managed Royce & Associates, LLC. It invests in the public equity markets of the United States. The fund seeks to invest in stocks of companies operating across diversified sectors. It primarily invests in value stocks of companies with market capitalization of less than $500 million. The fund benchmarks the performance of its portfolios against Russell 2000 Index. Royce Micro-Cap Trust, Inc was formed on December 14, 1993.
Source: seekingalpha.com RMT
RMT has $480m in assets and incurs 135bps in fees. As the next chart shows, the yield varies greatly as do the quarterly payouts, shown later.
Source: seekingalpha.com Yield
Royce Investment Partners adds some flavor and a critical distinction from the Seeking Alpha information.
Why invest in Royce Micro-Cap Trust?
• One of the only closed-end funds dedicated to investing in micro-cap stocks. Micro-cap stocks’ market caps are less than the largest stock in the Russell Microcap® Index.
• Core approach that combines multiple investment themes and offers wide exposure to micro-cap stocks by investing in companies with strong fundamentals and/or prospects selling at prices that Royce believes do not fully reflect these attributes.
• Outperformed its benchmark, the Russell 2000 Index, for the 1-, 3-, 5-, 10-, 15-, 20-, 25-year, and since inception (12/14/93) periods ended 9/30/21.
Source: royceinvest.com RMT Factsheet
While RMT benchmarks its performance against the Russell 2000 Index, it restricts its investing based on the largest market-cap in the Russell Microcap Index. Russell describes that Index as:
The Russell Microcap® Index measures the performance of the microcap segment of the US equity market. Microcap stocks make up less than 2% of the US equity market (by market cap) and consist of the smallest 1,000 securities in the small-cap Russell 2000® Index, plus the next 1,000 smallest eligible securities by market cap.
Source: research.ftserussell.com
As of 11/30/21, that would have been Apollo Medical Holdings (AMEH) at $4.15b. With AMEH down 20% since then, I suspect current #2, Civitas Resources (CIVI) might be setting the limit. Lucky for RMT, CIVI's current size is $4.6b. Depending in how often the use that cap to set their investable universe would influence their turnover rate, which was listed as 17% in 2020.
Using data from 9/30/21 to be consistent, the weight of RMT in Microcap Index stocks was 49%; in the R2000 Index 67%, with 40% in both indices. About 12% of IWC's weight is in RMT stocks as there are 149 common assets.
Holdings review
This data is from 11/30/21
Source: royceinvest.com RMT
Author's note: Royce labeled the Weights column with the NAV ticker
Compared to a Large-Cap ETF, such as the SPDR S&P 500 Trust ETF (SPY), Industrials is biggest increase, with Technology giving up some of its weight. Later, I will compare this to IWC.
The Top 10 holdings as of that date were:
Source: royceinvest.com RMT
Sometimes with funds that hold under 300 stocks, the Top 10 can dominate the fund. That is not the case with RMT and with the largest allocation being 2.9%, the managers are not taking big bets on any stock. If you look at the 9/30/21 holdings, the largest position was also below 3%. At the other end, the smallest 25% positions by size are only 5% of the AUM. Unlike IWC, which is almost 100% in US stocks, RMT is about 21% international, which adds some currency risk.
Distribution review
Source: seekingalpha.com/symbol DVDs
Payments have consisted of income, ST & LT Gains and ROC, but none from that source since 2011.
Source: royceinvest.com DVDs
Like many CEFs, RMT uses a Managed Distribution Policy, which was explained in the Annual Report as
The Board of Directors of each of Royce Micro-Cap Trust and Royce Value Trust has authorized a managed distribution policy (“MDP”). Under the MDP, Royce Micro-Cap Trust and Royce Value Trust pay quarterly distributions at an annual rate of 7% of the average of the prior four quarter-end net asset values, with the fourth quarter being the greater of these annualized rates or the distribution required by IRS regulations. With each distribution, the Fund will issue a notice to its stockholders and an accompanying press release that provides detailed information regarding the amount and composition of the distribution (including whether any portion of the distribution represents a return of capital).
Source: Annual Report
RMT encourages investors to use their reinvestment plan, which is the default option. If held at a broker, your account setting becomes the default. If not set for reinvestment, some, maybe all, investors get a notice each time asking if they would prefer shares instead of cash. Reinvestment occurs at the lower of the market price or NAV, and as we will see, RMT regularly trades at a discount. More on this when I compare the funds next.
Which is better depends on the investor's strategy
Before I explain what I mean by that, let’s do some comparisons between the two funds. First unlike most CEFs, RMT does not use leverage. Here is how some key measures match up.
Source: Multiple; compiled by Author
There are some big differences in terms of fees and assets. I would rate IWC as the conservative choice due to its Investing style (Index vs Active) and the much higher number of assets owned (1760 vs 276). That said, RMT is more likely to find an undiscovered gem that impacts its performance. Being more aggressive also shows in that RMT is more dependent on their Top 10 performing well versus IWC.
Now, back to the heading which can be explained in two charts. The first assumes the investor plowed all payouts back into the fund.
Source: portfoliovisualizer.com
Since IWC started, RMT has both a higher CAGR, though most of the difference can be contributed to recent outperformance. While incurring more StdDev, the Sharpe and Sortino ratios still favor RMT. The results look completely different if the investor did not reinvest the payouts.
Source: portfoliovisualizer.com
Of course, the above chart is only half the picture, so I turned to another website, DividendChannel.com, which includes the payouts into the final CAGR.
Source: dividendchannel.com
The top set of data closely matches the first PV chart. Notice the share increase RMT has over IWC via payout reinvestment. The second set shows how much not reinvesting dividends impacted the return of both funds. With reinvestment, RMT was ahead by 90bps; without, IWC was ahead by 258bps. This can be seen in how the prices have moved.
The conclusion? Do not own RMT unless you plan on reinvesting your dividends. Considering RMT has not traded at a premium since 2007, buying shares below market generates an instant gain, something not available with an ETF.
Source: cefconnect.com RMT
Portfolio Strategy
Besides the asset allocation any investment provides, understanding your goals for that particular choice is just as important. As seen with RMT, buying a higher yielding asset and not reinvesting could negate the CAGR shown in most charts as the usual default used is reinvestment. I covered this concern in my article Not DRIPing High-Yield Securities Is Costly To Your ROI. The website, DividendChannel.com, which is free, is one place to see how much DRIPing or not effects the Total Return on an investment.
I did test using IWC or RMT with VOO; the results varied little: link
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This article was written by
I have both a BS and MBA in Finance. I have been individual investor since the early 1980s and have a seven-figure portfolio. I was a data analyst for a pension manager for thirty years until I retired July of 2019. My initial articles related to my experience in prepping for and being in retirement. Now I will comment on our holdings in our various accounts. Most holdings are in CEFs, ETFs, some BDCs and a few REITs. I write Put options for income generation. Contributing author for Hoya Capital Income Builder.
Disclosure: I/we have a beneficial long position in the shares of RMT either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.