Three Best Performing Small Cap Growth ETFs - ETF News And Commentary

By Zacks | August 29, 2012 AAA

The ongoing chaos in the domestic and European markets has put pressure on the growth of the global economy, just a few short years after the collapse of the market in 2008. Still, in an uncertain economic scenario, small cap growth funds are shining and outperforming their large and mid-cap counterparts.

Small Caps in Focus

These securities tend to have less correlation with the macroeconomic trends and offer investors a great opportunity to tap into a local economic performance. This makes these securities perfect for today's environment, in which the American economy is arguably leading the way higher, despite the global turmoil (read: Guide to Small Cap Emerging Market ETFs).

Furthermore, since these companies are so small, they have a much easier time growing than their already tapped out large cap counterparts. This trend is expected to continue in the remainder of 2012 and into 2013, especially if emerging markets stay weak and Europe continues to fight debt issues.

Growth Funds

Yet not all small caps are created equal with some being more focused on value and others targeting the growth segments of the market. Arguably, growth firms could be just the kick that many portfolios need as these offer above-average revenue and earnings growth with high price-to-book ratio but yield lower than the value and blend counterparts, making them interesting choices as yields are already depressed and not really up to historical levels.

Growth funds also increase more than the other funds in the booming period and falls drastically in the bearish phase. Since many are looking for a modest recovery, growth funds seem like a logical choice for those expecting a return to market health in the fourth quarter.

Small Cap Growth ETFs

Taken together, small cap growth funds are poised to offer larger returns but with higher risk. Investors seeking to invest in these funds should have higher risk tolerance, as these are extremely volatile and may lose or gain a great deal in a very short period.

As the market has come back and the focus has been on U.S. securities, there have been a number of ETFs in the space that have beaten the S&P 500 over the past year (as of August 24), making these great picks for diversified investors (see more ETFs in the Zacks ETF Center). Given this, risk tolerant investors might consider them in their portfolio for the long term.

So while many funds have beaten out large caps and value funds, we have taken a closer look at three of the best performing small cap growth ETFs so far this year. Compared to the S&P 500, these ETFs produced higher returns over the last year but lower year-to-date returns, making them intriguing choices for investors seeking more diversification and a greater focus on U.S.-centric equities:

Vanguard Small-Cap Growth ETF (VBK)

This is one of the largest and the most popular ETFs in the small cap growth space. The product outperformed the S&P 500 index by more than 180 basis points over the last year thanks to its diversification benefits and low cost structure.

The fund is well spread across various sectors and securities (read: Build a Complete Portfolio with These Three ETFs). Information technology takes the top spot in the basket followed by health care, industrials and consumer discretionary. With holdings of 930 securities, the ETF puts about 5.4% of the assets in top 10 firms, suggesting concentration risk of only 3.26%. Each security holds less than 1% share in the basket.

The product is the low cost choice in the small cap growth ETF space, charging only 10 bps in annual fees. It trades in good volumes of more than 1 million shares per day on average, suggesting a relatively low bid-ask spread.

The ETF uses full replication strategy to track the performance of the MSCI US Small Cap Growth Index, a subset of the MSCI US Small Cap 1750 Index. The fund has so far attracted about $2.1 billion in assets and was initiated in January 2004.

The product gained about 23.60% over the past year and 12.17% so far this year. However, like many on this list, the yield is lacking coming in at just 0.48% annually (see: Zacks ETF Rank).

iShares Morningstar Small Growth Index Fund (JKK)

This fund also outperformed the S&P 500 benchmark over the last year (as of August 24th) by more than 50 basis points. Like its counterparts, the product is widely spread across securities with less than 1% of assets in an individual firm. The top 10 holdings make up for 9% of assets in the basket.

The ETF also has nice allocations to various sectors. Technology represents the key element in the basket followed by health care, real estate and industrials (read: Why SSDD Is The Top Tech ETF).

The product seeks to replicate the Morningstar Small Growth Index, holding 257 securities in its basket. Launched in June 2004, the fund charges 30 basis points in fees per year. It produces a relatively higher bid/ask spread due to minimal daily transaction and has managed assets of $92.1 million so far this year.

The fund has delivered returns of about 22.32% over the last year (as of August 24) and 10.48% year-to-date. It pays an annual dividend of about 0.29%.

iShares S&P SmallCap 600 Growth Index Fund (IJT)

Launched in July 2000, the fund seeks to match the price and yield of the S&P SmallCap 600 Growth Index, before fees and expenses. The ETF outperformed the S&P 500 benchmark by 200 basis points in the last one-year period.

Like VBK, this product also has nice allocations to individual securities and sectors. It puts less than 10% of assets in top 10 holdings, each representing 1% share in the basket. From the sectors' look, the fund is slightly tilted towards information technology sector but makes a nice mix with other sectors such as health care, consumer discretionary and financials.  

This diversification provides the fund with a portfolio of 329 securities in total. The product is quite inexpensive given an expense ratio of 0.25%, low bid/ask spread and good tracking error (read: Guide to the 25 Cheapest ETFs). It trades in a volume of about 150,000 shares on a daily basis and yields low dividend of 0.59% per annum.

With AUM of $1.6 billion, the fund returned about 23.80% in the last one-year period (as of August 24) and 10.48% year-to-date.

The following table describes the returns of the three small cap growth ETFs, which are higher than the returns of the S&P 500 index for the one-year period:

ETF/Index

YTD Performance (as of 08/24/12)

1-Yr Performance (as of 08/24/12)

VBK

12.17%

23.60%

JKK

10.58%

22.32%

IJT

10.48%

23.80%

S&P 500

12.21%

21.73%

 
It should also be noted that all three of the ETFs allocate a large portion to information technology and health care sectors that are performing better than expected. As a result, the returns from these funds exceed the returns from the S&P 500, at least in the trailing 52 week period.

This focus on these two sectors could be helping all of these funds outperform in the time period in question. After all, IT demand is still pretty high in the U.S. market, especially on the consumer side, while health care has seen something of a boost thanks to a lower level of uncertainty after the Obamacare decision.

Given these factors, many investors have been piling into both of these market segments as of late, pushing values up for these sectors. With this backwind and the growth nature of these funds that target the small cap market, it has certainly been an advantageous time to get in on this economic sector. While there is no telling if this trend will continue, for investors who like IT and health care, any of the above listed market leaders could make for excellent picks in the short term.

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