Investing in microcap stocks, also called penny stocks, demands a higher degree of risk tolerance than investing in small-cap stocks because risk increases with lower market capitalization. One reason for this higher risk is the thin trading volume for microcap stocks, making it difficult to sell shares at the desired price within a reasonable time. Volatility increases with lower market capitalization. Microcap ETFs invest in stocks that typically have less than $300 million in value, compared to low-volatility large-cap stocks with market capitalizations in excess of $10 billion.

iShares Microcap ETF (IWC)

The iShares Russell Microcap ETF (IWC) is the largest microcap ETF. The fund had total net assets of more than $768.95 million as of March 2020. This ETF tracks the performance of the Russell Microcap Index by using a market capitalization weighting methodology. This ETF has an average daily trading volume of approximately 65,929 shares. Its trading volume provides reasonable liquidity for a sector comprised of individual penny stocks with thin trading volume.

The iShares Microcap ETF has a high expense ratio of 0.60%. The average ETF expense ratio is 0.44%. Financial sector stocks account for 22.07% of the 1,378 holdings for this ETF, health care sector stocks account for 28.01% of its holdings and information technology stocks make up 11.62% of the holdings.

First Trust Dow Jones Select MicroCap Index Fund (FDM)

With total net assets of approximately $79.7 million, the First Trust Dow Jones Select MicroCap Index Fund (FDM) was the second-largest microcap ETF. It tracks the performance of the Dow Jones Select MicroCap Index.

The rules of the Dow Jones Select MicroCap Index assign component weights according to market capitalization, trading volume, and the following financial indicators: trailing price-to-earnings (P/E) ratio, trailing price/sales ratio, per-share profit change for the previous quarter, operations profit margin, and six-month total return. The largest holding of this ETF, with 2.59% of the portfolio weight, is Kodiak Sciences Inc. (KOD). The remaining assets in the top 10 holdings of this ETF are penny stocks.

The First Trust Dow Jones Select MicroCap Index Fund experiences a thin, average daily trading volume of 4,633 shares. This ETF has a high 0.60% expense ratio. Financial sector stocks account for 32.47% of the 205 holdings of this ETF, industrial sector stocks account for 17.93% of its holdings and consumer cyclical stocks make up 14.98% of the holdings. Health care sector stocks comprised 7.98% of the ETF's weight.

AdvisorShares Dorsey Wright Microcap ETF (DWMC)

The AdvisorShares Dorsey Wright Microcap ETF (DWMC) is an actively-managed portfolio of microcap stocks--perhaps one of the rare or few actively managed ones. It was started in 2018, making it relatively new ETF, but is one of the most well-known in the microcap ETF market. To date, it has approximately $1.4 million in assets under management.

DWMC's portfolio is led by Five9, Inc. (FIVN) and has a total of 159 funds. Approximately half of these funds come from the lower half of the Russell 2000 Index and a mixture of other penny stocks. The top two sectors that comprise the microcap ETF's holdings are in the technology and the financial sectors, each accounting for about 21% of the ETF. Close behind follows the healthcare and industrials sectors, at 19.02% and 13.50% respectively. While its expense ratio is high at 1.25%, due to the fund's active management, beginning investors interested in microcap stocks could find more rest in the AdvisorShares Dorsey Wright Microcap ETF.