A Big Idea Among Small-Cap ETFs For 2017

Small-cap stocks and exchange-traded funds have been receiving plenty of notoriety in recent weeks. With many of the ETFs tracking smaller companies recently hitting record highs, investors are right to start to evaluating which ones can keep the upside coming in 2017.

The WisdomTree SmallCap Earnings Fund (ETF) (NYSE:EES) is one small-cap ETF that is performing well in 2016 with the potential to extend its bullishness into the new year.

EES' Index

EES follows an index that holds almost 960 stocks. What is most important about that index is that it only includes companies that have displayed profitability over the previous four fiscal quarters. Often times, small-cap investors are willing to sacrifice a company's profitability for its growth prospects, but EES does not subscribe to that line of thinking.

What investors need to know is that the index EES tracks and the ETF itself have been around since February 2007, and over that time, the WisdomTree index has delivered a higher Sharpe Ratio, meaning superior risk-adjusted returns, than the Russell 2000, according to WisdomTree data.

Proof Of Strategy

EES is also proving itself to be more than suitable to the current market environment, one where investors are reconciling the results of last month's U.S. presidential election and the specter of up to three interest rate hikes in 2017.

Here in the U.S., mid- and small-cap stocks have led the market rally since November 8 and have outperformed most of the major asset classes, said WisdomTree Chief Investment Officer Luciano Siracusano in a recent note. Given the large outperformance of mid- and small-cap companies, is this an area of the market that investors should continue to focus on in 2017? I believe it is, if one can manage for the valuation risk of buying into these asset classes after 2016's large run-up.

Since November 9, the first trading session after Election Day, EES is up 15.1 percent. On the other hand, the Russell 2000 Index and the S&P SmallCap 600 Index are up 10.9 percent and 12.6 percent, respectively. This is not new territory for EES, which has outpaced the Russell 2000 by more than 1,300 basis points over the past three years.

Small caps are seen as durable in the face of rising interest rates because many smaller companies generate the bulk of their revenue within the United States, meaning they benefit from a stronger dollar. Conversely, large-cap multi-nationals are potentially vulnerable to a stronger greenback by virtue of international sales.