While ample evidence exists to support the assertion that some small ETFs outperform larger equivalent and deliver impressive returns, small ETFs have an abundance of critics.
These naysayers often, and erroneously so, focus on $100 million in assets under management being the barometer of whether an ETF is "good" or not. To this day, there is no empirical evidence to support the notion that ETFs with over $100 million in assets under management generate superior returns.
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As S&P Capital notes, "there are a number of ETFs with asset bases below $100 million that are ranked favorably" by the research firm. However, investors do need to acknowledge some important issues with small ETFs, including often higher bid/ask spreads that are found with diminutive ETFs.
"Less frequent trading can lead to wide bid/ask spreads, which is the gap between the price buyers are willing to pay for shares of an ETF and the price sellers are asking," said S&P Capital IQ in a new research note. "The wider the spread, the bigger the bite taken out of investors' returns every time they buy or sell."
S&P pointed to the PowerShares Fundamental Pure Small Core Portfolio (NYSE:PXSC) as an example of a small ETF with unfavorable cost factors. PXSC has a net expense ratio of 0.39 percent, but S&P said the fund's small asset base ($14.6 million) and low average daily volume (about 1,950 shares) contribute to a less-than-bullish view of the fund.
S&P favors the large and heavily traded iShares Russell 2000 Index Fund (NYSE:IWM) over PXSC. IWM, which has $19.3 billion in assets under management, charges an annual fee of 0.25 percent. S&P has rates IWM Overweight, but has an Underweight rating on PXSC.
The RevenueShares Navellier Overall A-100 Fund (NYSE:RWV), which ranks its 100 holdings by revenue rather than market capitalization, also caught S&P's eye. The research firm pointed out RWV has an expense ratio of 0.6 percent, just $7 million in AUM and is thinly traded, contributing to wide bid/ask spreads and a Marketweight rating.
As alternative to RWV, S&P highlighted the $203.1 million PowerShares S&P 500 High Quality Portfolio (NYSE:SPHQ). SPHQ tracks an index that selects S&P 500 members for inclusion based on long-term dividend and earnings stability. SPHQ is home to 136 stocks, including Procter & Gamble (NYSE:PG), Walt Disney (NYSE:DIS) and PepsiCo (NYSE:PEP). S&P rates SPHQ Overweight.
"The ETF holds stocks with above-average S&P Quality Rankings of A- or higher (based on their strong earnings and dividend consistency and growth)," said S&P Capital IQ in the note. " SPHQ is not only more diversified than RWV, but also has favorable cost factors. SPHQ trades over 45,000 shares daily and has a tight bid/ask spread. In addition, the gross expense ratio of 0.49% (netexpense ratio of 0.29%) is much more reasonable than RWV's."
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