Micro-Cap ETFs; Real Estate ETFs

Micro-cap stocks generally refer to U.S. publicly traded companies with a market capitalization between $50 million and $500 million. Micro-cap ETFs are exchange-traded funds that focus on this segment of the market. However, most micro-cap indexes target specific deciles of capitalization, or exclude a fixed quantity of larger stocks, so the actual upper bound often approaches $1 billion.

Companies with a market capitalization of less than $50 million are often labeled nano-cap stocks, although some sources will include these smaller stocks within the micro-cap classification.

Because of their sheer numbers and small market values, these stocks often do not receive adequate coverage by Wall Street analysts and brokerage houses. Reduced coverage means less scrutiny, lower liquidity, higher volatility, and increased risk. The SEC publication “Microcap Stock: A Guide for Investors” provides potential investors with information on regulation, trading, and risks of investing in these securities. One of the primary benefits of using ETFs to get exposure to this area of the market is the single-security risk mitigation provided by the diversification achieved from owning hundreds of these stocks.

There are currently four U.S.-listed micro-cap ETFs, and all have been on the market for a minimum of 10 years. Here they are listed in order of fund asset size:

iShares Micro-Cap ETF (IWC), launched 8/17/2005, seeks to track the Russell Microcap Index, which excludes the 2,000 largest U.S.-listed companies by market capitalization. The ETF holds 1,352 stocks with an average market capitalization of $463 million. It has $850 million in assets and an expense ratio of 0.60% (IWC overview).

First Trust Dow Jones Select MicroCap (FDM), launched 9/30/2005, seeks to track the Dow Jones Select Microcap Index, which is designed to represent U.S.-listed micro-cap stocks that are liquid and have strong fundamentals relative to the micro-cap segment as a whole. It covers securities whose market capitalizations fall within a range defined by the bottom two deciles of NYSE stocks. It uses a multifactor screen of fundamentals, momentum, and liquidity to arrive at an ETF holding 515 stocks with an average market capitalization of $515 million. It has $82 million in assets and an expense ratio of 0.60% (FDM overview).

Guggenheim Wilshire Micro-Cap (WMCR), launched 9/21/2006, seeks to track the Wilshire Micro-Cap Index, which excludes the 2,500 largest components of the Wilshire 5000 Index. The ETF holds 802 stocks with an average market capitalization of $187 million (the smallest of the four Micro-Cap ETFs). It has assets of $27 million and an expense ratio of 0.59% (WMCR overview).

PowerShares Zacks Micro Cap (PZI), launched 8/18/2005, tracks an index designed to identify a group of micro-cap stocks with the greatest potential to outperform passive benchmark micro-cap indexes and other actively managed U.S. micro-cap strategies. The ETF holds 401 stocks with an average market capitalization of $427 million. It has just $25 and an expense ratio of 0.50% (PZI overview).

The accompanying chart shows that the average market capitalization of these ETFs typically falls in the $400 million to $500 million range. The primary exception is the Guggenheim Wilshire Micro-Cap ETF (WMCR) with its $187 million average market capitalization. For reference, the chart also includes the iShares Russell 2000 ETF (IWM). The Russell 2000 Index is the most widely followed benchmark of small-cap stocks, but with an average market capitalization of $1.7 billion, the Russell 2000 average market capitalization is about four times that of most Micro-Cap benchmarks.

The 2017 “ETF Field Guide” awarded its “best-of-breed” blue star designation in the U.S. Micro-Cap ETF category to First Trust Dow Jones Select MicroCap (FDM). This designation is based on performance and risk, with screening for liquidity and expense ratios. In 2016, FDM returned 35.9%, while the second-place finisher lagged far behind with a 24.1% return. Its 10-year annualized return of 7.3% was 2.1% ahead of its nearest competitor. Its 3-year maximum drawdown was held to 17.8% versus drops of 23.9% to 28.7% for the other three.

For my money, the First Trust Dow Jones Select MicroCap ETF (FDM) is the first place you should look when considering a micro-cap ETF for your portfolio.

Weekly Edge

Utilities tops the sector rankings, but it was the Real Estate ETFs making the largest upside move. Financials, the prime post-election beneficiary has run out of gas. Momentum continues to lead the factors scorecard, and a three-way tie has developed among the global categories

Sectors: Utilities claimed the top ranking among the Sector Benchmark ETFs. It had been lurking in the second-place spot for the preceding three weeks and reached the pinnacle today. However, the momentum scores reveal that this new achievement was not so much the result of strength in Utilities as it was weakness in Technology. Both sectors lost momentum this past week, but Technology lost more, causing it to relinquish the top spot and slide down to second. Real Estate was the big upside mover, jumping four spots higher to claim the fourth-place position. Health Care was the largest downside mover, falling from fourth to seventh. Telecom had a good week, moving from red to green and climbing a notch higher. Financials went the other direction, losing the last of its positive momentum and slipping lower in the rankings. The election boost for Financials appears to be out of gas. The momentum scores continue to become more compressed, which often precedes and precipitates large changes in the relative-strength rankings. The 49-point spread of two weeks ago was down to 32 points last week, and there is just a 20-point difference from top to bottom today.

Factors: Momentum is in the driver’s seat for a fifth consecutive week. The rapid factor rotation of late February and early March appears to have stabilized for now. Low Volatility was the ruling factor for most of 2015 and early 2016 but fell out of favor in the last half of 2016. It moved back into the upper half of the Factor Benchmark ETF rankings five weeks ago and sits in second place today. Growth slipped to third and now sits just below Low Volatility. High Beta continued to recover from the two-week plunge that took it from first to last in late February. Last week’s rise off the bottom to claim eighth place was followed by another two-spot rise today. High Beta and Value were the only two factors gaining momentum over the past week, but Value remains on the bottom.

Global: There is a virtual three-way tie for first place among the Global Benchmark ETFs. Latin America, Eurozone, and Pacific ex-Japan all posted momentum scores of 21 today. China is close to making it a four-way tie, but this is not necessarily a four-way show of strength. They all got this way by losing momentum, some more than others. Latin America lost 9 momentum points, Eurozone gave up 7, China declined 5, while Pacific ex-Japan held its loss to just 3 points. If this short-term trend persists, the relative-strength rankings are going to look much different the next couple of weeks. Canada was the only global category to increase its momentum this week, and its reward was a move up and out of last place. Japan fell a notch and is now at the bottom.

The following Edge Charts are market momentum snapshots. They provide a quick and easy way to help you visually get a handle on the overall state of the market. With these charts, you can assess both the relative strength and absolute strength (momentum) of more than 30 global equity market segments. Please refer to the Edge Chart User’s Guide for further explanation.

“I think you have to learn that there’s a company behind every stock,
and that there’s only one real reason why stocks go up. Companies go from
doing poorly to doing well, or small companies grow to large companies.”

—Peter Lynch

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