Time to Celebrate Small Cap Stocks

By Tom LydonETFsFOXBusiness

Large-cap U.S. stocks have been stalwarts, but smaller companies and exchange traded funds that track the small- and mid-cap categories are beginning to race ahead.

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Over the past three months, the iShares Russell 2000 ETF (NYSE:IWM) rose 11.1%, SPDR S&P MidCap 400 ETF (NYSE:MDY) gained 11.3% while the SPDR S&P 500 (NYSE: SPY) returned 7.6%. Mid-caps have also been a standout asset category, with MDY rising 6.5% year-to-date, whereas SPY advanced 3.2%.

Small-caps have been gaining momentum in recent months, capitalizing off the risk-on sentiment after the Fed stated it would only raise interest rates two times later this year, downwardly revised from the four hikes it expected back in December. The extended low-rate environment also benefited smaller companies that have taken on cheap debt in their balance sheets.

Looking ahead, small-caps can still navigate through a slowly rising rate environment. Smaller companies, which cater toward U.S. domestic markets, are less exposed to a stronger U.S. dollar as rates rise, which would more negatively weigh on large-caps with a global footprint. Additionally, periods of rising rates also coincide with expanding economies, which often benefit smaller companies.

The lower reliance on multinational sales has also supported mid-caps. Additionally, the mid-cap segment has provided favorable acquisition targets when cash-heavy large-cap companies are shopping around.

Moreover, middle-capitalization stocks may offer a suitable middle ground between more volatile small-caps and less mobile large-caps. Mid-cap companies are slightly more diversified than their small-cap peers, which allows many of the companies to generate more consistent revenue and cash flow and provide more stable stock prices. Additionally, they are not so big that their size would slow down growth. Consequently, mid-caps have generated historically higher returns than large-caps, with higher volatility and higher beta, but at a lower ratio of return-to-risk than small-caps.

Among the best recent small-cap performers, the PowerShares Russell 2000 Equal Weight Portfolio (NYSE:EQWS) increased 3.6% and Schwab U.S. Small-Cap ETF (NYSE:SCHA) rose 2.8%.

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EQWS takes an equal-weight position on the Russell 2000. Compared to the benchmark Russell 2000, the equal-weight methodology has a much lower financial tilt at 10.9% and smaller information technology position at 13.3%. The indexing methodology also makes the fund overweight micro-caps at 62.7% of the portfolio.

SCHA tracks the Dow Jones U.S. Small-Cap Total Stock Market Index, which also includes some mid-cap and fewer micro-cap stocks than in the Russell 2000. The Schwab offering is also the cheapest on the block, with a 0.08% expense ratio.

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Additionally, the Guggenheim Mid-Cap Core ETF (NYSE:CZA) and ProShares S&P MidCap 400 Dividend Aristocrats ETF (NYSE:REGL) are among the best performing mid-cap ETFs this quarter, rising 4.5% and 3.1%, respectively.

CZA tries to reflect the performance of the Zacks Mid-Cap Core Index, which targets companies with superior risk-return profiles as determiner by Zacks Investment Research. However, due to its indexing methodology, the fund is more focused that the benchmark S&P MidCap 400. For instance, St. Jude Medical (NYSE:STJ) makes up 2.7% of CZA's portfolio, and the ETF includes a hefty 32.8% tilt toward financials and 17.1% to industrials. Moreover, CZA includes a 11.6% position in large-cap names.

REGL tracks the S&P MidCap Dividend Aristocrats Index, which only includes a targeted 46 dividend paying companies that have raised payouts for 15 consecutive years. The indexing methodology makes the tilt toward the value style and quality names. The ETF also comes with a slightly more attractive 1.54% 12-month yield.

This article was provided by our partners at etftrends.com.

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