With central banks globally, including the Fed, leaning toward a dovish policy of easing interest rates, it may be time for investors to take a refreshed look at U.S. small cap equities. After a strong start to the year, U.S. small caps have been a bit battered by trade war storms, which have demonstrated that small caps are not less vulnerable to such unrest than large caps. The result has been a decline in small-cap valuations that might appeal to long-term investors given that smaller companies sometimes obtain benefits from easing and lower interest rates.
For investors currently looking for value in small caps, liquidity and risk management (an ongoing priority, according to 75% of CIOs1) are imperative – and increasingly, they are pursuing those attributes through cost-efficient ETFs. According to a recent Greenwich Associates report, asset owner allocations to ETFs increased to 25% of total assets in 2018, a jump of 6% from one year earlier. In the report, 81% of investors cite liquidity as a primary reason they use ETFs1.
Diversification while tracking a popular benchmark
Another strength of ETFs is the market access they provide, according to 79% of institutional investors. In small caps in particular this is highly valued, as resources to conduct research on individual small companies can be limited. However, with an ETF such as the iShares Russell 2000 ETF (IWM), investors gain exposure to 2,000 small caps with more than $1.4 trillion in AUM benchmarked to the Russell 2000 Index.2 This broad coverage may reduce the need for a dedicated research team, and allows investors to diversify their U.S. stock portfolio as they seek long-term growth. Such diversification is one aspect of risk management in a portfolio, and IWM can provide this diversification in an inexpensive and transparent way of shifting allocations.
In addition, IWM, which has more than $40 billion in net assets, has provided deep liquidity for U.S. small cap exposure. The fund has consistently ranked in the top five for liquidity among all U.S.-listed ETFs on a daily basis.3 The low cost – particularly in large size trades where IWM is much more cost efficient than trading countless small cap stocks – flexibility, potential liquidity, and transparency of an ETF like IWM, demonstrate why, among the 40% of institutional investors who have replaced other investment vehicles with ETFs, 45% have used ETFs to replace index mutual funds.
1 Greenwich Associates 2018 U.S. Exchange-Traded Funds Study. Based on interviews with 181 institutional investors including investment managers, institutional funds, insurance companies, RIAs and other types of institutional investors, between 10/2018 and 12/2018. BlackRock sponsored the study and is not affiliated with Greenwich Associates.
2 FTSE Russell, 12/31/2018
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