Financial Pros Make This Their Top Small Cap ETF

Traditionally, small cap stocks offer higher risk and higher reward.

But that isn’t always true of the small cap indexes or ETFs.

You see, once a small cap stock grows large enough, it gets bumped up to the mid-cap category.

So, indexes like the Russell 2000 are self-selective.

That’s why they’re usually not good investments unless you believe in a broader economic boom.

Maybe that’s what markets are telling us as the once lagging iShares Russell 2000 ETF (IWM) has begun to outperform some tech indexes.

Not to be left behind, financial pros began looking into this ETF in earnest back in late May, with search volume increasing week after week.

That’s why we wanted to take a look at the IWM and some competing small cap ETFs to find the best of the bunch.

Key Facts About IWM

• Net assets: $53.83 billion
• 12-month trailing yield: 1.45%
• Inception: May 22, 2000
• Expense ratio: 0.35%
• Number of holdings: 1904

The IWM is the most broadly traded and liquid small cap ETF in the market.

Following the Russell 2000 index methodology, the IWMincludes the 2,000 smallest companies by market capitalization from the Russell 3000 index. Companies are weighted based on market cap, and the index is reconstituted annually.

Because stocks are removed once they exceed a certain threshold, the weighting for each company remains fairly balanced, with no company accounting for more than one half of one percent of the total index.

Source: Ishares

What most people don’t realize is the IWM holds more regional bank stocks than other indexes like the S&P 500.

This gives it a much heavier weighting towards financials than technology.

Source: Ishares

Performance

Over the last 20 years, small caps vastly underperformed mid and large cap indexes.

The Great Recession and subsequent banking reforms made it more difficult for regional banks to grow. As such, the IWM underperforms other indexes except when coming out of recessions.

Source: Ishares

To give you an idea, the S&P 500 ETF (SPY) gained over 70% during the last five years.

Competition

Small cap stocks come in all shapes (not so much sizes, pun intended). The following are some alternatives to the IWM from Blackrock, State Street, and Vanguard.

• iShares Russell 2000 Growth ETF (IWO): The IWO takes a different spin on small caps, selecting stocks with higher growth prospects.
• iShares Core S&P Small-Cap ETF (IJR): Instead of using the Russell 2000 index, the IJR leans on the S&P SmallCap 600, a smaller subset of companies with a similar methodology as the IWM.
• SPDR S&P 600 Small Cap Growth ETF (SLYG): The SLYG is State Street’s version of the IWO, using the S&P 600 small cap index as its baseline instead of the Russell 2000.
• Vanguard Small Cap ETF (VB): Vanguard’s small cap index operates like the IWM, selecting a larges subset of small cap equities, just at rock bottom costs.

The winner of the 5-year return happens to be Vanguard, where its lower cost helped it outperform the other ETFs.

It’s also worth noting the ‘growth’ small cap ETFs don’t outperform the baseline ETFs.

Our Opinion 7/10 

While the IWM has plenty of liquidity, we can’t argue with the outstanding performance of the VB amongst small caps.

And with a lower expense ratio, it’s one of the few Vanguard ETFs we like for its niche.