Scoop Up Some Small Caps

Small-cap stocks can seem either unnecessary worries or undervalued fruits ripe for the picking, depending on your stomach for risk. But wary investors can find a middle ground in small-cap exchange-traded funds, or ETFs.

The small-cap ETFs tend to carry enough holdings so that no single stock has a weighting of more than 1%, which means that individual companies can't overly influence returns. But the composition details vary -- and there is no guarantee that you can find an ETF to match your investment style. Here are three small-cap ETFs to consider.

Blended
The iShares Russell 2000 ETF  (NYSEMKT: IWM  ) works for investors looking for a broad small-cap basket without any particular slant. Its $27 billion in assets stretch across nearly 2,000 holdings.

This ETF could easily help form the bulk of a new portfolio when stacked with other funds tracking a subset of the Russell 3000. Examples include the large-cap iShares Russell 1000 Growth ETF and the iShares Russell Midcap Index.

There is a cheaper option than the iShares' small-cap fund. The similarly structured Vanguard Russell 2000 Index ETF (NASDAQ: VTWO  ) spreads $535.5 million in assets across 1,991 holdings. However, the young ETF has only one year of net-asset-value returns available for comparison.

Growth  
The iShares S&P Small-Cap 600 Growth ETF (NYSEMKT: IJT  ) tracks an index that weights holdings according to fundamentals including sales growth and momentum. So the holdings favor faster growth and higher market caps. This ETF spreads $2.7 billion in assets across 356 holdings.The top five holdings do have more than 1% weight apiece, and the leading sectors include information technology, financials, and consumer discretionary.

A potential downside to this ETF is that the market can already price in future potential -- meaning that the growth stocks might not grow as much in the future. But this ETF has managed decent historic NAV returns and could provide a nice satellite holding for an investor who's willing to actively monitor it.

Value
Vanguard Small-Cap Value ETF (NYSEMKT: VBR  )  tracks the CRSP US Small-Cap Value Index with $10.4 billion in assets spread across 803 stocks. The index is weighted according to value metrics, including forward P/E, return on assets, and historical and forward earnings-per-share growth.

Finding undervalued small caps means making a bet that the companies will exceed expectations in the future, which adds an extra layer of risk. But as you'll see in the table below, this ETF bests the others in NAV returns. And taking this risk comes at a cheaper price: The Vanguard ETF trades at about $10 less than the iShares offerings.

Performance comparisons 
Here's a metrics comparison to bring these ETFs into focus.

Fund

Expense Ratio

Dividend Yield

1-Year NAV

3-Year NAV

5-Year NAV

iShares 2000

0.25%

1.74%

24.26%

18.66%

8.8%

iShares 600

0.26%

1.1%

22.03%

20.65%

9.75%

Vanguard

0.1%

2.2%

25.76%

19.18%

8.94%

Vanguard has strong historical NAV returns, but its more volatile nature doesn't guarantee such returns in the future. But the low expense ratio and high dividend yield might serve as a buffer against that risk.

Blended iShares Russell 2000 is a predictably middle-of-the-road choice. The growth iShares 600 has a lower dividend yield, as the companies need to keep more money on hand to fuel growth. The expense ratio is higher but still reasonable, and the returns nearly match those of the blended ETF. But the iShares 600 has the same risk problem as the Vanguard ETF.

Foolish final thoughts 
You don't want to make a small-cap ETF the center of your portfolio, but these options could provide nice satellite holdings. Blended ETFs offer the safest way to invest in a basket of small caps, but the growth option has better multiyear returns -- if you're willing to take on the extra risk in hopes for an even better future. And those with gambling souls can see how the value ETF fits into a stabilized portfolio.

To learn more about a few ETFs that have great promise for delivering profits to shareholders, check out The Motley Fool's special free report "3 ETFs Set to Soar." Just click here to access it now.


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