ETF Strategy Focus: Small & Midcap Stocks

Dec 12, 2010
When we launched the ETF Relative Strength Reader module on November 17th, we used a current example of a market rotation toward mid-cap stocks within the introduction video (the video is here: RS Reader Tools Page ).   Since then, this mid-cap ETF segment has shown strong continuation upward, consistent with the relative strength concepts on which our site is focused.  

Owning small companies is a classic strategy that is implemented not to reduce risk – but to enhance overall portfolio return.   The argument goes that small cap companies are generally more dynamic than large cap companies --- with greater growth rates and generally in less mature sectors.   

The story you don’t hear as often is that small cap companies can also be quite fragile.    With the higher growth-rates also comes higher execution risks.   Thus, small cap investing is an information-intensive business.   Hedge funds and large institutions have dramatically better resources to gain an information edge.   However, there is a catch-22 for the investment manager --- success in small cap investing bloats your asset base and then you can no longer be nimble enough to take advantage of your information edge.  

Small cap indexes are higher beta (more aggressive) strategies by their nature.    You don’t need to buy leveraged funds (ie the 2x and 3x funds) that suffer from very significant structural flaws --- instead of such funds, if you want to express more aggressive views, you can do so simply with more aggressive, unlevered strategies.   One such is small cap.   Think of small cap not as ‘your permanent strategy’ --- but one of many return-enhancing strategies at your disposal.   

I find this idea of international small cap investing quite intriguing.   It has simply not been possible to do this kind of thing in the past (at reasonable cost and with such precision).   These ETFs for the most part are not very liquid yet --- and many of these are brand new.   But this is one of 50+ examples of the TYPES of things that ETFs are essentially inventing:  ways for the advisor and sophisticated individuals to pursue ultra low-cost strategies that 1) don’t require stock-picking and yet 2) offer the ability to add significant value over a core allocation.







Note: Ameritrade, Fidelity, Schwab and Vanguard all have one or more small cap ex-US products that are zero commission --- and of course all have extremely low expense ratios. It's quite amazing really when you think about it.


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ETFreplay does not provide investment advice.  All content of this blog refers to past relationships.


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