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Time for This Low Risk Small Cap ETF?

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The growing fear about the health of the international economy, especially the emerging nations, has led investors to shift their focus to the U.S. economy, which although not entirely immune to the challenges, has still shown promise since the second half of 2012. Notably, mid and small cap stocks have played a vital role in carrying the bullish momentum.

Given this improving trend in the U.S. market and the assuring data from Europe, equities could be set to rise higher in the days ahead. While there are some bumps in the road ahead like the possible tapering of the Fed’s bond buying program or Syrian issues, longer-term bullish sentiment for stocks remains unruffled.

History has shown that smaller companies generally bounce back in a reviving economy faster than the larger ones. Hence, we might see an upturn in small companies in a market which has been bestowed with better job, inflation and to some extent housing data (Read: Play Surging Health Care with These Small Cap ETFs).

Small-cap stocks are generally focused on the domestic economy which makes them unperturbed in the present global doldrums. That is why, in our opinion, pure U.S. exposure can best be achieved via small cap securities.

Last but not least, while it is not yet known whether the central bank will begin to slow down the bond buying program from this month or later this year, the market is already prepared for the inevitable move. We thus can expect lesser volatility even after the step is formally taken. 

Given this bullish 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. One way to find a top ranked ETF in the small-cap space is by using the Zacks ETF Ranking system (read: Zacks ETF Rank Guide).

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 see all the Zacks ETF Categories here). 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 (see more in the Zacks ETF Center).

For investors seeking to apply this methodology to their portfolio in the small-cap space, we have taken a closer look at the highly ranked IJR. This ETF has a Zacks ETF Rank of 2 or ‘Buy’ (see the full list of top ranked ETFs) and is detailed below:
About IJR
Launched in May 2000, iShares Core S&P Small-Cap ETF (IJR - Free Report) is a passively managed ETF designed to track the performance of the S&P SmallCap 600 Index. The fund has been designed to tap small cap securities of the U.S. equity market.

The fund is one of the popular choices in the small-cap space with about $11 billion in AUM. Holding 603 stocks in its basket, the product puts only 5.75% of its total assets in the top 10 holdings, suggesting minimal concentration risk.  As such, we have a ‘Low’ risk outlook for IJR in the near term (Read: Buy This Top Ranked Small-Cap Value ETF).

The product is well diversified across each security as none of them holds more than 0.68% of the assets. Cubist Pharmaceuticals, Questcor Pharmaceuticals and Gulfport Energy hold the top three positions in the basket.

This choice is an inexpensive one in the small-cap ETF space with 17 bps of annual fees which is lower than the average expense ratio of the space. The fund is also liquid with a daily trading volume of around 900,000 shares which takes the second spot after iShares Russell 2000 Index Fund (IWM - Free Report) .
The fund structure follows a blend style. Greater exposure to blend style also calls for lower volatility. Notably, the fund has almost all its coverage in the U.S. which clearly explains why it can be a wise bet in a global slowdown.
The fund returned a robust 25.0% in the one-year period ending August 30, 2013 and about 18.0% in the year-to-date time frame. In fact, IJR has beaten the S&P 500 index over the past three, five and ten years.
The product also pays an annual dividend yield of 1.37%. IJR hit a low of $70.94 and a high of $98.34 over the last one year. The fund is currently hovering around its 52-week high price.

Bottom Line

While small caps are often capable of higher levels of growth than large caps, these can also be subject to increased volatility. Given this, amongst the top performing small-cap ETFs, IJR has a lower risk outlook, thus defying the usual nature of small-caps, and potential for greater return.

Further, the fund is inclined to the financial sector, which came up with strong corporate earnings and an upbeat outlook in the latest season, and should send this category to another rally this fall as well.

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