The iShares Russell 2000 ETF: 3 Reasons to Buy

By Markets Fool.com


Small companies can deliver big rewards. Photo: Flickr user George Redgrave

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If you're interested in the stock market and want to invest in it, a good way to do so is with an exchange-traded fund (ETF) that's based on a broad index. A great one for most folks to start with is the SPDR S&P 500 ETF, tracking the 500 big American companies in the S&P 500 index. But that only exposes you to large companies. Thus, consider the iShares Russell 2000 ETF , too.

Here are some key reasons you might want to become a shareholder:

Easy and cheap

As with most mutual funds and ETFs, the iShares Russell 2000 ETF offers you convenience. With an expense ratio (annual fee) of just 0.20%, you won't be paying much (only $10, for example, on an investment of $5,000) -- and you'll instantly be invested in roughly 2,000 companies! (They're the ones in the Russell 2000 index, as you might have suspected.)

Investing in an index fund is also easy because it saves you a lot of stress and decision-making. You don't have to follow and keep up with any of its holdings, deciding whether to buy, hold, or sell. That's what the fund's managers do, and in the case of a fund like this that tracks an index, changes are up to those who maintain the index, who periodically remove and replace companies.

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And here's a bonus for this cheap and easy investment: dividends. A typical small company won't offer a dividend, because it needs to plow any excess cash back into growing its business. But enough of this ETF's 2,000 holdings make a regular payout to shareholders that it does offer a dividend yield, which was recently around 1.3%.

Diversification

Then there's diversification, another desirable trait. You might be diversifying your portfolio by adding small companies to your mix via this ETF, but this ETF itself is diversified, across many industries. Its assets are not spread out equally among them, though. Here's a recent breakdown:

  • Financial services: 25.2%
  • Technology: 14.8%
  • Consumer discretionary: 14.6%
  • Healthcare: 14.3%
  • Producer durables: 13.4%
  • Materials and processing: 6.6%
  • Utilities: 4.5%
  • Energy: 3.5%
  • Consumer staples: 2.9%

If you're really bullish on the financial industry (and it does have a terrific track record of wringing fees and other revenue from its customers), then this ETF delivers such stocks in spades. If you have the highest expectations for the utility industry, then you won't be getting a lot of exposure to it. Still, you will have your money spread out among a wide variety of industries, with no more than about 25% in any one of them.


Big oak trees grow from acorns.
Photo: Flickr user tfengreen

Great potential

Finally, there's potential, because smaller companies can grow more briskly than larger ones. (The average size of this ETF's components is about $1.5 billion.) Small-cap stocks often outperform large-cap ones, though that has happened a bit less recently. According to the folks at AllianceBernstein, "If we look back to 1979 -- a period spanning 35 years of performance history -- small-caps fared worse versus large-caps in only about 5% of the observed three-month periods."

In an article about a year ago, the AAII Journal recalled the research of Eugene Fama and Kenneth French, who found: "[I]n monthly returns between July 1926 and February 2012, small-cap stocks outperformed roughly 51% of the time. During that time, small-cap stocks also delivered a cumulative excess return of 253% relative to large-company stocks."

This ETF is also an easy way to be invested in lots of small companies you probably haven't heard of and would have to work hard to discover on your own. Here are just a few components, and why they're promising:

  • CalAmp Corp. is a wireless networking specialist whose shares have fallen in value while its earnings have risen, producing what some see as an attractive entry point for this free-cash-flow producer. Its last quarterly report, for its third quarter, delivered better-than-expected earnings and management expects a boffo fourth quarter. Bulls like its free cash flow, rising gross margin, and involvement in the promising "Internet of Things" arena, such as via its technology that lets machines communicate with each other and its user-based insurance technology, letting insurers track customer behavior (such as via driving data from a car) and charge accordingly. Meanwhile, bears worry about a rising share count and the company's reliance on a few major customers.

  • Isis Pharmaceuticals, has averaged annual growth of nearly 13% over the past 20 years, which is quite impressive and it advanced 12% just last month. It has 32 drugs in its pipeline, but only one approved by the FDA so far. Though it has often partnered with bigger, deep-pocketed companies in the past on many drugs, it's striking out on its own with some now, too, and bulls were heartened recently by a big debt offering which will keep the threat of stock dilution at bay for a while. It has been weighed down by a weak launch of its Kynamro cholesterol drug, and many of its drugs will take years to exit its pipeline. But overall, it's an intriguing long-term proposition, especially if its stock pulls back to a more attractive valuation.

  • InvenSense Inc : This specialist in motion-sensing technology has seen its stock drop almost 50% from its 52-week high on weak earnings. Its fans believe that its long-term potential remains intact, as it has new markets it can tap, such as wearable technology and game consoles. It has done well supplying high-end smartphones, and has an opportunity to target mid-range ones with its technology. It's also growing its revenue faster than its peers. Doubters, though, see it as overvalued relative to its peers and don't like its reliance on two major customers (Appleand Samsung, to be specific) that have been putting pressure on its profit margins. It has turned in losses instead of gains recently and is free-cash-flow negative, too.

Whether you buy them on your own or opt for a simple and easy index fund, it's smart to include small caps in your portfolio.

The article The iShares Russell 2000 ETF: 3 Reasons to Buy originally appeared on Fool.com.

Longtime Fool specialist Selena Maranjian, whom you can follow on Twitter, owns shares of Apple, InvenSense, and Isis Pharmaceuticals. The Motley Fool recommends Apple, CalAmp, InvenSense, and Isis Pharmaceuticals. The Motley Fool owns shares of Apple and InvenSense. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.