Until recently, investors who wanted to own shares of the smallest U.S. companies through exchange-traded funds had no options. But since September, they've had three.
Although they all focus on very small stocks, the new offerings — the iShares Russell Microcap Index Fund (IWC), the First Trust Dow Jones Select MicroCap Fund (FDM), and the PowerShares ETF-Zacks MicroCap Fund (PZI) — differ in their investment approaches and holdings.
The $71 million iShares ETF introduced by Barclays Global Investors tries to match as closely as possible the performance of its benchmark, the Russell Microcap index.
The fund's bogey contains about 2,000 stocks, but Barclays narrows that down to about 1,200, seeking those that are the most representative of the index and that can be traded the most easily without significantly affecting their prices.
"The focus here is on liquidity," said Patrick O'Connor, a senior portfolio manager at Barclays who heads the team that oversees the ETF. A company's financial fundamentals are not a consideration for gaining entry into the fund, he said.
That's not the case with First Trust's ETF. Companies judged to be in poor health are excluded from the $35 million fund, which holds about 300 stocks. It looks at things like profit margins, stock valuations and total returns.
The $87 million PowerShares fund, which owns around 330 stocks, also operates more actively. Like other ETFs offered by the company, Zacks Microcap tracks an index composed of stocks seen as having the greatest potential to outperform a passive benchmark as well as actively managed funds.
Sectors favored by the three funds can also vary. Information technology companies account for about 22% of the PowerShares fund's portfolio. The iShares fund has roughly the same percentage in financial services companies. (Sector holdings for the First Trust fund were not immediately available.)
The funds do, however, have the same expense ratio: 0.60%. That's much lower than the 1.87% expense ratio sported by the average micro-cap mutual fund.
In debuting the ETFs, fund industry observers said the three companies were trying to take advantage of investors' thirst for small-cap stocks, which they noted have performed better than large-caps over the last few years. Micro-cap stocks are generally defined as those of companies with market capitalizations of $350 million or less.
Shauna Ginsberg, a research analyst with fund tracker Financial Research Corp., said the companies are also trying to leverage the popularity of ETFs, whose assets have swelled in recent years. Unlike mutual funds, ETFs trade throughout the day and can be sold short.
