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ETF News And Commentary

Small-Cap Value ETFs are ideal for investors seeking equity appreciation with a lower level of risk. This is especially true in the dividend ETF world, as many top income funds have seen huge inflows in the past couple of years amid an ultra-low interest rate.

Although, of late, some investors began to reconsider their bond holdings for the long term thanks to early taper fear that resulted in rising interest rate scenario, value investing remains as popular as ever. A host of issues are involved in this.

Even if 10-year treasury yields rose from 1.6% in May to the current 2.8% plus level, yields are still low by historical standards. The fact still keeps value investing a rising star. With the global markets still recovering, many investors seek stability in their investments, along with a good rate of current income. This still makes a dividend-focused value ETF a wise bet.

Further, the U.S. stock market is currently hovering at lofty levels. This is especially true for mid and small cap stocks which have played a vital role in carrying the bullish momentum forward outperforming their large cap counterparts. Small-caps are leading the way higher as we move into Q3 (read: 3 Small Cap ETFs Leading the Market Higher).

A decent enough Housing Starts and Permits data and sharp drop in Jobless Claims data indicate that the market should move higher in the coming days as well thus pumping more fresh blood to small-cap U.S. stocks.

Plus, in case of small-caps, a smaller scale of operations and ability of cash generation compel these companies to remain regional and restricted from being export-driven. This attribute makes small cap US equity space a superior choice for betting on the inherent strength of the US economy at a time when increased correlation with various other struggling nations may price in the latter’s slowdown.

Given this trend, a look at some of the top ranked ETFs in the space could be a good way to target the best of the segment with lower levels of risk. In order to do this, investors can look at the Zacks ETF Rank to find the top small-cap value fund.

About the Zacks ETF Rank

The Zacks ETF Rank provides a recommendation for the ETF in the context of our outlook for the underlying industry, sector, style box or asset class (Read: Zacks ETF Rank Guide). Our proprietary methodology also takes into account the risk preferences of investors. ETFs are ranked on a scale of 1 (Strong Buy) to 5 (Strong Sell) while they also receive one of three risk ratings ─ namely Low, Medium or High.

The aim of our models is to select the best ETFs within each risk category. We assign each ETF one of the five ranks within each risk bucket. Thus, the Zacks ETF Rank reflects the expected return of an ETF relative to other products with a similar level of risk.

For investors seeking to apply this methodology to their portfolio in the small-cap value investing sector, we have taken a closer look at the top ranked VIOV. This ETF has a Zacks ETF Rank of 1 or ‘Strong Buy’ (see the full list of top ranked ETFs) and is detailed below.

About VIOV

Launched in Sep 2010, Vanguard S&P Small-Cap 600 Value ETF (VIOV - ETF report) is a passively managed ETF designed to track the performance of the S&P small-cap 600 Value Index.

The choice is quite inexpensive in the space, as it charges only 24 basis points a year in fees which is decently lower than the average expense ratio in the small-cap value space. Holding 444 stocks in its basket, the product puts only 8.4% of its total assets in the top 10 holdings, suggesting the very little concentration risk.

The fund has now amassed as much as $29.6 million. Quite expectedly, with just under $30 million in AUM, it isn’t exactly the most popular ETF in the space. This leaves the fund with paltry trading volumes. Its daily trading volume of around 3,000 is also quite light compared to more well known small-cap value ETFs like iShares Russell 2000 Value ETF (IWN), Vanguard Small-Cap Value ETF (VBR) and iShares S&P SmallCap 600 Value Index (IJS).

In terms of sector exposure, financials (22.7%) and industrials (18.4%) both account for more than 40% of assets, while consumer discretionary (14.8%) and IT (13.7%) round out the top four. Stocks are also well diversified from an individual holding perspective, as no single company makes up more than 1.1% of assets (see Create a Diversified Portfolio Using ETFs).

Also, greater exposure to small cap stocks may call for higher volatility as it helps to garner smart returns. As such, we have a ‘Med’ risk outlook for VIOV in the near term.

The fund has returned about 19.3% so far this year. The fund is currently hovering near its 52-week high level. VIOV pays out a yield of 1.08% per annum. Over the last one-year period, the return from VIOV (30.1%) outperformed the SPDR S&P 500 ETF or SPY (18.6%) as of August 16, 2013.

Bottom Line

VIOV, a nice combo of stocks with below average PEs, a more stable earnings profile and small capitalization, could be a winner thanks to its high exposure to financial and technology sector which has been rebounding nicely. According to Markit, Insurance, Banks and Technology sectors are most favorable from a dividend point of view which likely enhance the value of the fund (Read: 3 Excellent ETFs for Growing Dividends).

On the other hand, smaller companies generally bounce back in a reviving economy faster than the larger ones. Hence, we might see an upturn in small caps in the improving market which should make the fund a quality choice to tap the space.

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