Investors Buy Big Into Small-Cap ETFs

Recent performance suggests that good things do, in fact, come in small-cap packages, leading to a run on small-stock-focused exchange-traded funds, according to a story in the Wall Street Journal.

In fact, in the last year, some small-cap-oriented funds doubled their assets, forcing some small-cap mutual funds to begin shuttering to new investors. This has only increased the interest of overseas investors and hedge funds seeking entrée to U.S. small companies with market capitalization of $1.5 billion or less.

Because they trade like single stocks, exchange-traded funds, or ETFs, offer solutions for each of these.

The most popular types of small-cap ETF appears to be those with a wide array of both growth and value stocks.

So far this year, small-cap ETF have attracted $2.2 billion in assets, compared to $262 million of outflows during 2005, according to Financial Research Corp. Between December and February, the collective assets under management have swollen from $12 billion to $15 billion.

Barclays Global Investors manages nine small-cap-focused ETFs. Year to date, the assets in these nine have increased 21%. Especially active is the iShares Russell 2000 ETF. Prudential Equity Group small-cap strategist Stephen DeSanctis attributes this activity to the increasing interest of hedge funds.

"Hedge funds want exposure to small-caps," DeSanctis said. While small companies have been delivering high growth lately, ETFs allow hedge funds to invest in a range of companies, rather than single shares, which can be less liquid.

Pension funds also account for much of the recent ETF asset swell, according to Dina Ting, portfolio manager for Barclay's ETF division.

"Foreign investors are also going beyond large-caps and going into the smaller-caps," Tin said.

Last year, the Russell 2000 ETF, a mix of value and growth stocks that tracks the Russell 2000 small-cap index, delivered returns of 13.9%, compared to less than 4% for the S&P 500. By the end of March, the fund had $2.2 billion more under management than at the end of December.

"Registered investment advisors are showing particular interest in small-cap ETFs as a low-cost way to gain broad exposure to small caps for their clients," a Vanguard spokeswoman told The Wall Street Journal.  Vanguard has three ETFs, which nearly tripled in assets between March 2005 and March 2006.

Analysts warn that the small-cap ETF frenzy may slow this year, along with their earnings. "Hedge funds will want to get out, and then you will start to see the money come out," DeSanctis said.

The staff of Money Management Executive ("MME") has prepared these capsule summaries based on reports published by the news sources to which they are attributed. Those news sources are not associated with MME, and have not prepared, sponsored, endorsed, or approved these summaries.