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Small Cap ETFs in Focus as Domestic Growth Picks Momentum

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Large Caps vs. Small Caps


U.S. small-caps have been continuously lagging their large-cap counterparts this year. Large-cap stocks have been growing on stepped-up global economy, owing to their high international exposure. Small-cap stocks on the other hand are more domestically focused and exhibit higher volatility than their large-cap counterparts.


The largest small-cap ETF tracking the Russell 2000 index, iShares Russell 2000 ETF is up 10.7% so far this year, while the SPDR S&P 500 ETF is up about 15%.


The primary reason for this underperformance can be attributed to investors piling onto blue chips and shunning the small-caps. However, with robust domestic economic growth and rising hopes of President Donald Trump’s tax reform, small-cap stocks are expected to perform well.


Economic Data


U.S. equities have been rallying owing to multiple factors. GDP increased 3% annually in the July-September period compared with a 3.1% increase in the third quarter. Also, it surpassed expectations of a 2.5% increase (read: 5 ETFs to Soar After Solid Q3 GDP Data).


Trump is expected to announce his decision on the Federal Reserve chair this week. Markets believe that Trump is expected to choose Fed governor Jerome Powell as Janet Yellen’s replacement. Powell is being seen as a dovish candidate who will not steer much from the current Fed policy. Markets widely expect the Fed to hike rates in its December meeting.


On Oct 19, the Senate passed a budget of $4 trillion in a 51-49 vote which will allow the Republicans to move ahead with the tax cuts with a simple majority instead of the 60-vote supermajority that is generally required (read: GOP Nears Tax Reform: Buy These ETFs).


The tax reform is expected to significantly boost earnings. This led to a rally in the stock markets as investors grew more optimistic about Trump delivering on his campaign promises. Moreover, it will significantly boost the performance of small-caps owing to their domestic focus.


However, the markets are worried about the tax cuts rolling in gradually, instead of an immediate cut. This will be contrary to Trump’s wishes and markets’ expectation of an immediate cut.


Let us now discuss a few ETFs focused on providing exposure to U.S. small-cap equities.


iShares Russell 2000 ETF (IWM - Free Report)


This fund seeks to provide exposure to small cap U.S. companies and tracks the Russell 2000 index.


It has AUM of $43.6 billion and charges a fee of 20 basis points a year. From a sector look, the fund has high exposures to Financials, Information Technology and Industrials with 18.4%, 17.2% and 15.2% allocation, respectively (as of Oct 27, 2017). The fund’s top three holdings are Bluebird Bio Inc (BLUE - Free Report) , Exact Sciences Corp (EXAS - Free Report) and MKS Instruments Inc (MKSI - Free Report) with 0.3%, 0.3% and 0.3% allocation, respectively (as of Oct 30, 2017). The fund has returned 26.5% in a year and 10.7% year to date (as of Oct 31, 2017). It has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook.


iShares Core S&P Small-Cap ETF (IJR - Free Report)


This fund is one of the most popular ETFs traded in the U.S. markets. It seeks to provide exposure to small cap companies.


It has AUM of $34.2 billion and charges a fee of 7 basis points a year. From a sector look, the fund has high exposures to Industrials, Financials and Information Technology with 19.1%, 16.6% and 15.8% allocation, respectively (as of Oct 27, 2017). The fund’s top three holdings are MKS Instruments Inc, Lumentum Holdings Inc (LITE - Free Report) and Allete Inc (ALE - Free Report) with 0.8%, 0.5% and 0.5% allocation, respectively (as of Oct 30, 2017). The fund has returned 26.9% in a year and 8.9% year to date (as of Oct 31, 2017). It has a Zacks ETF Rank #3 with a Medium risk outlook.


Vanguard Small-Cap ETF (VB - Free Report)


This fund seeks to provide exposure to small cap U.S. companies and tracks the CRSP US Small Cap Index.


It has AUM of $20.0 billion and charges a fee of 6 basis points a year. From a sector look, the fund has high exposures to Financials, Industrials and Technology with 25.5%, 20.5% and 11.3% allocation, respectively (as of Sep 30, 2017). The fund’s top three holdings are Teleflex Inc. (TFX - Free Report) , Take-Two Interactive Software Inc. (TTWO - Free Report) and CDW Corp. (CDW - Free Report) with 0.3% allocation each (as of Sep 30, 2017). The fund has returned 23.0% in a year and 11.3% year to date (as of Oct 31, 2017). It has a Zacks ETF Rank #3 with a Medium risk outlook.


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