Time For This Top Ranked Small Cap ETF?

Large cap stocks have recently fallen out of favor with investors, as losses have begun to mount in S&P 500 securities. Plus, in terms of ETF outflows, (SPY) has been leading the pack in recent weeks, as billions have moved out of this ultra-popular product.

This trend, along with global market weakness, is forcing many to look at small cap securities for exposure instead. These have held up reasonably well in this environment, and thanks to more of a domestic focus, could be better positioned in the months ahead as well.

However, just looking at the most popular small cap ETFs in the market might not be the best way to play this trend. In fact, the most popular product in the space, the iShares Russell 2000 ETF (IWM), has actually added just over 3.5% in the past three months, while it is currently sporting a Zacks ETF Rank #4 or ‘Sell’ (also see the Zacks ETF Rank Guide).

Better Plays
Fortunately, there are a number of better ranked—and better performing—ETFs in the small cap space out there. One such fund that fits this bill is the WisdomTree Small Cap Earnings ETF (EES).

This product receives a top Zacks ETF Rank of 1 (Strong Buy) and it has been one of the top three performing small cap ETFs over the past three months. In fact, its return in this time frame of 6.64% thoroughly crushes IWM’s 3.53% move higher in the same period, suggesting that investors may want to give this ETF another look.

EES in Focus
EES tracks the WisdomTree Small Cap Earnings Index, which is a fundamentally weighted index that measures the performance of earnings generating companies within the small-cap segment of the U.S. stock market. To be included, firms must have generated positive earnings over the most recent four fiscal quarters, and be listed (as well as incorporated) in the United States.

It is also worth noting that the index is earnings weighted on a yearly basis, in order to reflect the proportionate share of the aggregate earnings each component company has generated. In other words, companies with greater earnings will have larger weights in the index, irrespective of their market capitalization levels.

This produces an ETF that has roughly 900 stocks in its basket, charging investors 38 basis points a year in fees. Exposure is quite spread out though, as no single company accounts for more than 1.25% of the total.

The fund does have a bit of a concentration in certain sectors though, as financials (24.4%), consumer discretionary (18.8%), and industrials (17.6%) take the top three spots. The product is really light in telecoms and utilities, as these account for less than 3% of the total combined.

While this is both a cheap and outperforming pick in the sector, it should be pointed out that volume is a little light, while yield leaves a bit to be desired too. The 30-Day SEC payout is below 0.8%, while volume is generally below 30,000 shares a day. This may increase bid ask spreads, though the relatively liquid nature of the underlying holdings should prevent this from becoming too big of an issue.

Still, the ETF has been a great pick as of late, and it has beaten out both its large cap and small cap brethren, suggesting it could be a solid selection for investors seeking quality exposure to the U.S. market at this time.


Bottom Line
Some investors have begun to focus on small cap securities as of late, thanks to their domestic focus and better growth prospects. However, many investors are likely focusing in on products like IWM that have lagged.

Instead, a better play might be in the top ranked segments of the small cap world, like with a fund such as EES. This product, thanks to its interesting weighting methodology, has outperformed as of late and could be a better choice for investors to play the small cap ETF space to close out the year.

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