Over time, the up and comers of the market have demonstrated the potential for better risk-adjusted returns than larger cap stocks in certain economic environments.If you want capital growth, the small cap equity asset class is the place to be; however, picking individual small cap stocks that will outperform is no easy task. These higher volatility, lower volume equities present an unfavorable risk/reward when evaluated individually, leading investors to consider ETFs to gain small cap exposure for their portfolio . The Schwab U.S. Small-Cap ETF (SCHA) offers a well-diversified portfolio with a lower expense ratio than most of its peers.



In A Nutshell

SCHA is a relatively new addition to the small cap ETF space. Introduced to the market on November 3rd 2009, SCHA seeks to replicate the performance of the Dow Jones U.S. Small-Cap Total Stock Market Index.

The index is a subset of the Dow Jones U.S. Total Stock Market Index representing the stocks ranked 751-2,500 by market cap.



What Makes SCHA Unique

For investors looking for an ETF that tracks the Dow Jones U.S. Small-Cap Total Stock Market Index, SCHA is their only choice. With more than 1,700 securities in its portfolio, this ETF is deep and diversified removing much of the risk associated with the volatility of small cap stocks. In addition to its depth, SCHA is well balanced. With only 2.5% of the fund's assets in its top 10 holdings, assets are spread throughout all classes including growth and value stocks .



How It Fits

Small cap ETFs have a place in nearly every investor's portfolio and should serve as a core holding. Because small cap equities are perceived as being riskier than larger companies, the return will likely outpace the market giving small cap ETFs more growth potential over time. ETFs in this asset class should make up 5% to 20% of a portfolio.

SCHA may not be suitable for an investor who has a low tolerance for volatility. Small cap. ETFs often see heightened volatility compared to the market. Investors with a lower risk tolerance should consider a lower weighting of small cap. exposure in their portfolio.



What It'll Cost You

SCHA is the cheapest small cap equities ETF available to investors. It has an expense ratio of only 0.10% compared to the Small Cap Blend Equities ETFdb Category average of 0.39%. For investors with a Charles Schwab account, SCHA is available to them as a commission free trade.



Under The Hood

Investors looking for an ETF that follows the traditional rules of diversification will like SCHA. It has more than 1,700 securities in its portfolio covering all sectors of the economy. SCHA's top five holdings include Medivation, Inc., Dresser-Rand Group, Inc., Duke Realty Corp, tw telecom inc., and Ariad Pharmaceuticals. 99% of its holdings are in U.S. stocks well balanced between sectors.

The industrials sector holds the most assets at 19% with technology comprising 15% of the fund. Consumer Cyclicals comprise 13%, Financials 12%, and health care 10% .

SCHA invests primarily in small cap. stocks. Only 20% of the companies represented in the index are micro cap names and 20% are medium cap. Because the fund tracks an index comprised of the 751th-2,500th largest stocks by market cap, companies may gain or lose value moving them slightly above or below the index's definition of small cap. With 61% of holdings comfortably in the small cap. category, investors can be confident that the fund holds true to its objective.



Yield, Volatility and Performance

SCHA offers a quarterly dividend and its expected volatility should be higher than broad U.S. markets but below emerging market benchmarks. Since SCHA has only been in the market for three years, long term performance data is unavailable but in 2011, the fund lost 3% of its value compared to the average of other ETFs in the space that lost more than 3%, though that was after surging 28% the prior year.



Other Options

  • iShares Russell 3000 (IWM): This is the most popular small cap fund with over $16 billion in assets under management. IWM has an expense ratio nearly 3 times higher than SCHA.
  • PowerShares FTSE RAFI US 1500 Small-Mid Portfolio (PRFZ): This ETF uses the RAFI methodology which selects securities based on fundamental measures like book value, cash flow, sales, and dividends.
  • Vanguard Russell 2000 ETF (VTWO): VTWO has the deepest portfolio totaling over 2,000 individual small cap securities. It has an expense ratio of 0.22% and is commission free through Vanguard.
Disclosure: Long IWM

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Tickers in this Article: IWM, PRFZ, SCHA, VTWO

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