Three Small Cap Value ETFs Poised To Outperform

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September 16, 2013 3:54pm NYSE:FYT NYSE:SLYV

etfs etfsAlthough concerns over Syria and the taper have eased, markets are still having trouble finding their footing. However, even in this uncertain environment, small caps have been leading the way higher as of late.

In fact, over the past three months, small caps, as represented by the popular ETF (NYSEARCA:IWM), have added about 7.4% in the past month, compared to a gain of just under 4% for SPY and nearly a flat return for DIA in the same time frame.

Investors should note that small caps were underperforming in the early part of the second quarter but are now leading the way. Since small caps are considered to be the barometer of domestic economy, their dominance gives a bullish outlook for the U.S. in the near term (read: Time to Focus on Small Cap ETFs?).

Given this, small caps could be an excellent choice for investors seeking a top pick in today’s market environment. These pint-sized securities usually focus more on the domestic market, helping them to hold up better than their globally exposed peers. This is especially beneficial when a myriad of woes are hitting a number of developing and emerging nations.

Furthermore, by honing in on value stocks in this capitalization level, more safety can be assured to investors. These small cap value funds offer exposure to a wide variety of stocks with value characteristics, such as low P/B, low P/S and low P/E ratios, which reduce risks.

Additionally, value small cap funds tend to exhibit higher risk adjusted returns than large and growth stocks. The additional return that the investor gets in these funds is the risk premium, as both value and small cap stocks are deemed as risky investments.

Further, investors may want to consider cycling into the small cap value space in order to obtain a nice momentum play as we move ahead in the second half of the year. While looking at individual companies is certainly an option, a focus on top ranked small cap value ETFs could be a less risky way of tapping into the same broad trends.

Top Ranked Small Cap Value ETF in Focus

We have found a number of ETFs that have the top Zacks ETF Rank of 1 or ‘Strong Buy’ rating in the small cap space and are thus expected to outperform in the months to come.

While all these top ranked ETFs are likely to outperform, the following three funds could be good choices to tap into the space. This trio has enjoyed a strong momentum in the year-to-date period, and has potentially superior weighting methodologies which could allow it to continue leading the small cap value space in the months ahead.

SPDR S&P 600 Small Cap Value ETF (SLYV)

This underappreciated ETF offers exposure to the small cap value sector of the U.S. equity market, by tracking the S&P SmallCap 600 Value Index. Holding 445 stocks in its basket, the fund provides a nice balance across each security and prevents heavy concentration. None of the securities hold more than 1.04% of the total assets.

In terms of sectors, financials and industrials take the top spots at roughly one-fifth of the total each, followed by modest allocations to consumer discretionary and information technology (read: 3 Surging Financial ETFs Beating the Market).

The product has amassed $198.5 million in its asset base while volume is light, suggesting that bid/ask spreads are relatively wide and that total costs will come in much higher than the 31 bps expense ratio.

The ETF currently has a Zacks ETF Rank of 1 or ‘Strong Buy’ rating with a ‘Medium’ risk outlook, suggesting that it is positioned to outperform similar competitors. The ETF has gained nearly 5.8% in the past three months and over 20.6% so far in the year.

Vanguard S&P Small-Cap 600 Value ETF (VIOV)

This ETF tracking the same index could also be an exciting pick for investors. The fund holds about 444 companies in its basket while volume is rather weak and charges investors a fee of 24 bps a year. Still, the product is unpopular with $30.4 million in AUM.

Like its SLYV counterpart, the product is widely spread out across each security and sector, as no single company accounts for more than 1.1% of total assets. From a sector perspective, financials occupy the top position at 22.7% while industrials, consumer discretionary and information technology round off to the next three spots.

This product also has a top Zacks ETF Rank with a similar risk outlook, suggesting that it is poised to outperform in the long run and especially over other choices in the space. The ETF added 6.4% in the past three months, and is up over 21.5% year-to-date.

First Trust Small Cap Value AlphaDEX Fund (FYT)

For a slightly more ‘active’ choice in the mid cap world, investors should consider FYT for quality exposure. The fund is a bit pricey, as it charges 70 basis points a year in fees, and trades in small volume. It has managed assets worth $46.7 million so far in the year.

The reason for this extra cost is the AlphaDEX methodology, which seeks to taper the small cap space to only the best positioned companies. It ranks the stocks in the space by various growth and value factors, eliminating the bottom ranked 25% of the stocks.

As such, FYT should generate positive alpha relative to traditional passive indices since it uses AlphaDEX methodology and allots higher weights to more favorably ranked firms.

There are about 258 stocks in this fund’s basket, with industrials and consumer discretionary taking the top two spots. The product is well spread out across individual securities as no single firm holds more than 0.75% of assets.

Insight Enterprises, Ebix and Stewart Information Services Corporation occupy the top three positions in the basket.

The product has a top Zacks ETF Rank of 1 or ‘Strong Buy’ rating with Medium risk outlook though, and is poised to lead the market higher. The fund has moved higher by 4.5% in the last three months and over 21.1% in the year-to-date timeframe.

Bottom Line

To sum up, small caps have been surging for much of 2013 on the back of high betas and their focus on the booming U.S. market (read: 3 Small Cap ETFs Leading the Market Higher)

Since most of the ETFs in this category have risen significantly on this trend, investors shouldn’t forget the small cap space and should take a closer look at a few of the top ranked ETFs in this sector for excellent exposure and some more outperformance in the coming months.

This article is brought to you courtesy of Eric Dutram.

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