Lawrence Meyers: My favorite asset class is small-cap stocks. That’s because it is where you are most likely to find interesting little companies that other people pass over. They may do something unusual or exotic, and that can scare away most investors.
Most of all, however, it is where you are most likely to find the stocks that will outperform the market over the long term. That’s just pure common sense – small companies have much more room to grow to become large companies than large companies have to become, well, even larger.
So when it comes to small-cap ETFs, I really like to take my time finding the ones that may suit different investors. There are a lot of different approaches to small-cap investing, but here are the three small-cap growth ETFs that I think might be most interesting to the average Joe investor, aggressive investor and conservative investor.
The best small-cap growth ETF for the conservative investor might just be the PowerShares Fundamental Pure Small Cap Growth Portfolio (NYSEArca: PXSG), which will have changed names by the time to you read this to PowerShares Russell 2000 Pure Growth Portfolio.
The “pure” approach is designed to select only those stocks from the Russell 2000 that are truly growth stocks, according to a specific criteria.
The ETF first removes the largest 90% of cumulative fundamental weight from a universe of stocks, and turns on its screening criteria for the remaining 10%. This includes finding the best five-year average sales, cash flow, book value and dividend stocks among the remainder. Even then, the remaining stocks get compared to the sector to see which are growing faster than their peers – i.e., growing the fastest.
The fund holds 409 stocks, so there is lots of diversification, so that if a sector should struggle or a company go bankrupt, it won’t drag the whole fund down.
The top 10 positions in the fund only account for 12% of asset base. The sector breakdown includes 28% financials, 3% energy, 12% health care, 14% consumer discretionary, 25% IT, 12% industrial and 4% consumer staples.
To give you an idea of what the fund’s approach results in for its top holdings, its largest position is Skyworks Solutions Inc (NASDAQ: SWKS) at 2.71%, MSCI Inc. (NYSE: MSCI) and Kilroy Realty Corp. (NYSE: KRC).
The Average Joe will want to stick with a famous fund family for small-cap growth, namely, Vanguard Small-Cap Growth ETF (NYSEArca:VBK). Of biggest import is Vanguard’s historically low expense ratios, which in this case comes in at a mere .09%.
Of course, that low cost means you are getting a passively managed strategy that is really just a mirror of the small-cap index.