In the world of investing, bigger is not always better. Smaller companies usually have more room for growth and, if bought at the right time, can deliver outsized returns.
Investors looking to pivot to the latent potential hidden in smaller stocks have a new built-for-purpose exchange-traded fund (ETF) to size up.
On October 3, Zacks Investment Management launched The Zacks Small and Mid Cap ETF (“SMIZ”) on the New York Stock Exchange Arca. SMIZ will hold around 200 small and mid-cap stocks, more or less, and aims for positive risk-adjusted returns and diversification benefits to the Russell 2500 and Russell Midcap Index.
By leveraging their “Utilizing the Zacks Proprietary Multi-factor Alpha Model,” the ETF’s managers pick highly liquid stocks for the portfolio, factoring in analyst agreement, magnitude, upside, and surprise. Zacks claims this mixed quantitative-qualitative method selects for a basket of stocks that move more independently of the broader market and whose returns are minimally correlated to benchmark indices.
“The strategy is essentially a 50/50 blend of our small- and mid-cap products,” Zacks’ Head of ETF Products Salvatore Esposito said. “We’re not chasing high earnings growth. We’re seeking more balanced risk-adjusted performance and diversification.”
Zero in on Earnings
In addition, SMIZ’s portfolio managers will do a daily review of all analyst and estimate revisions, the percentage of earnings estimate revisions revised upward, and the size of the earnings estimate revisions. Zacks believes this laser-like focus on earnings movements can give their fund an edge.
“There’s more surprise and more earnings estimate revisions with small- and mid-cap names because they have less analysts covering that space,” Esposito added. “There’s more chance of choosing a company that can generate additional alpha than with large-caps.”
Where’s Russel’s Hustle?
Small and midcaps have not gotten much love this year.
At the start of October, the 2023 returns from the small-cap Russell 2000 index dipped into negative territory – and for not the first time this year. Its lips are just above water now – the index is up a mere 0.3% year-to-date.
This reflects a broader truth about this year’s perplexing market recovery. Some analysts have dubbed it the “skinny bull” – a tight cohort of tech mega caps (Microsoft, Meta, Nvidia, and the like) that have almost single-handedly driven up the S&P 500 and Nasdaq 100’s double-digit gains.
In aggregate, smaller caps have had little to show. Yet a closer look at the little guys’ fundamentals reveals signs of hidden potential.
By many measures, small-cap stocks are currently much cheaper than mega-caps. By the end of October’s opening week of trading, the average price/earnings (P/E) ratio of both the Russell 2000 and the S&P SmallCap 600 indexes was less than 13. By contrast, the S&P 500’s P/E ratio was 21, and the tech-heavy Nasdaq 100 at 29.
A lower P/E ratio indicates a stock could be undervalued if the market underestimates its potential for future profits.
Could it be time to hit pause on Silicon Valley giants and give the rest of the market a go?
In sizing up SMIZ, investors will likely look over their portfolios to see what weighting makes sense for smaller stocks. They may also consider how small and mid-caps could fare in 2024, when most money managers expect a recession to hit.
The net expense ratio for SMIZ is 0.56%.