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(Shapiso/© Lee Phek Thong, all rights reserved)
(Shapiso/© Lee Phek Thong, all rights reserved)

ETFs

Russell 2000 ETFs are models of growth and diversity Add to ...

When it comes to diversity, this ETF may be the reigning champ. Its portfolio consists of 1,960 equity holdings, none of which account for more than 0.35 per cent of the total. Replicating an index that is often over-shadowed by its behemoth counterparts, the S&P 500, the Dow Jones Industrial and the NASDAQ, Russell 2000 ETFs have evolved into one of the market’s favourite sons.

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In Canada, the iShares Russell 2000 Index Fund has amassed $126-million in assets under management. South of the border, the iShares Russell 2000 Index Fund is amongst the top ten biggest ETFs available in the U.S. market, with total assets of $21.5-billion (U.S.).

Not bad for a collection of small caps.

For Canadians looking to expand the scope of their portfolios, there are multiple ways to invest in domestic small caps. iShares has the S&P/TSX SmallCap Index Fund, S&P/TSX Completion Index Fund, and S&P TSX Venture Index Fund. While XCS and XMD have meaningful assets under management, $131.3-million and $207.3-million respectively, they also have considerably more concentration in their top 10 holdings, which account for 13.4 per cent and 19.6 per cent of the total portfolios, versus just 3.0 per cent for XSU.

When it comes to adding the small cap space, there is an additional incentive to being insulated from the performance problems of single companies as their relative size makes them more vulnerable to adversity.

BMO ETFs also offers access to small caps stocks via its junior gold, junior oil and junior gas ETFs. The concentration amongst these three funds is significant (61.8 per cent, 36.3 per cent and 59.4 per cent respectively), without offering the advantage of sector diversification.

In contrast, the Russell 2000 offers a good balance of industry exposure with Financials (23.9 per cent), Consumer Discretionary (14.8 per cent), Producer Durables (14.4 per cent), Technology (13.2 per cent) and Health Care (12.3 per cent), making up the bulk of the total.

The Russell 2000 is a subset of the Russell 3000, which includes the big cap names featured prominently in the S&P 500 (Exxon, Apple, General Electric). To arrive at the 2000, the largest 1,000 companies in the index, representing 90 per cent of the total, are jettisoned. The Russell 2000 proudly promotes the virtues of small caps, as the 2000 has consistently outperformed the 3000 over almost every conceivable time frame on a total return basis:

 

RUSSELL 2000

RUSSELL 3000

YTD (%)

7.43

6.88

1 year

14.02

13.65

3 year

14.71

13.83

5 year

7.35

5.38

10 year

11.16

8.85

 

The Russell 2000 is charting a similar course to the S&P 500 and the Dow, currently establishing new record highs. The ability to post higher growth rates going forward is arguably more attainable with small caps, as their penetration rates are much further from reaching the saturation point. These smaller firms are also more nimble, able not only to make quicker decisions that reverberate through the organization at an accelerated pace, but also able to reverse course or revamp their strategies in a way that is simply impossible for massive, intertwined companies.

Another attribute investors can leverage is visibility, or lack thereof. The likelihood of a smaller company being undervalued is greater as many do not register on equity analysts’ radars. As these companies grow, not only does the investor base climb exponentially, but their stocks get an additional boost from increased liquidity, which might also figure into a current discount.

A closer examination of some of the top performers in XSU reveals YTD returns that are off the charts, including:

 

YTD RETURN (per cent)

Caesars Entertainment Corporation

114.3

Lannett Company, Inc.

98.6

Orbitz Worldwide, Inc.

98.2

SunPower Corporation

88.2

Parkervision Inc.

84.3

 

When one of the big cap names generates this type of return, it becomes front-page news. Investors quickly flock to the opportunity and the ability to reap the rewards is short-lived. But, when the universe of stocks is expanded from hundreds to thousands, and the names shift from over-bought to under-appreciated, unprecedented performance becomes a somewhat expected event.

Much like a venture capitalist’s approach, where out of a portfolio of 10 companies only one or two need to breakout to achieve decent returns, the Russell 2000, evidenced by a long track record of beating the big caps, has proven its methodology is more reliable than counting on overweight winners to keep on winning.

Not bad for a collection of small caps.

ETFinsight is a website dedicated to helping Canadians connect with relevant ETF solutions. Read more at www.etfinsight.ca, follow us on Twitter@etfinsight and Josh Erhlich can be contacted at: josh@etfinsight.ca

Follow us on Twitter: @GlobeInvestor

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