IWM iShares Russell 2000

Currently, the broad markets are having trouble finding their footing due to growing concerns over the political deadlock in Washington. Yet, even in this backdrop, small cap securities are leading the market higher, and are easily outpacing their large and mid cap counterparts.
 
In fact, from a year-to-date look, small caps, as represented by the largest and most popular ETF (IWM), have added over 23%, compared to a gain of about 16% for SPY and just under 21% for IJH. The small cap ETF has gathered over $5.2 billion in assets so far in the year, propelling the fund’s base to roughly $27 billion.
 
The surge in small caps is expected to continue at least for the rest of the year assuming the risk-on trade comes back, and investors clamor for more domestic exposure. That is because small caps have been riding high on seemingly limitless QE, and could remain top picks if Washington gets its act together (read: 3 Growth ETFs to Buy for a Continued Small Cap Surge).
 
Interestingly, the top performers are spread across a number of sectors, suggesting that there have been winners in every corner of the space. Given this, small cap funds could be an excellent choice for investors seeking a top pick in today’s market environment.
 
Below, we have highlighted the top three sector ETFs that are outperforming in the small cap space and could be worth a closer look for those with a slightly longer time horizon (see: all the Small Caps ETFs here):
 
PowerShares S&P SmallCap Energy Fund (PSCE)
 
Energy has been a strong performing sector this year thanks to a solid trend in the energy exploration field and booming production in regions like the Dakotas and Texas. In fact, the sector has surged mainly due to a rise in U.S. oil production, which has cut down on the nation’s net oil imports (read: 3 Top Performing Energy ETFs in Focus Now).
 
One ETF that has largely benefited from this trend is PSCE. This fund tracks the S&P Small Cap 600 Capped Energy Index and holds 28 stocks in the basket. It is the least popular and is less liquid with AUM of $37 million and average daily volume of under 8,000 shares. The ETF charges 29 bps in fees per year from investors.
 
The product is largely concentrated across its top 10 securities with Gulfport Energy making up for 16.03% share alone in the basket. Other firms hold less than 9% of the total assets. About half of the portfolio is tilted toward exploration and production, closely followed by equipment & services (45%).
 
PSCE returned over 36% in the year-to-date time frame, clearly outpacing the broad sector fund (XLE) and other products by wide margin. The fund currently has a Zacks ETF Rank of 1 or ‘Strong Buy’ rating with a High risk outlook.
 
PowerShares S&P SmallCap Materials Fund (PSCM)
 
The materials sector is performing quite well this year on recovering U.S. fundamentals and a turnaround in global trends in wood products, chemicals, construction materials, and metals & mining (read: 3 Forgotten Ways to Play Mining Sector with ETFs). 
 
A good way to play this trend is with PSCM, which follows the S&P SmallCap 600 Capped Materials Index. This fund added 21.70% year-to-date, outpacing the broad sector fund (XLB) and other products by a wide margin. The ETF has accumulated $13.5 million in its asset base while volume is paltry, suggesting additional cost in the form of a wide bid/ask spread beyond the expense ratio of 0.29%.
 
With holdings of 29 stocks, the product is quite spread across various securities. PolyOne Corp, HB Fuller Co and Schweitzer-Mauduit International occupy the top three positions in the basket with less than 19% share. In terms of industry exposure, diversified chemicals, and forestry and paper products take the largest share at 37% and 21%, respectively. 
 
PSCM has a Zacks ETF Rank of 3 or ‘Hold’ rating with Medium risk outlook.
 
PowerShares S&P SmallCap Industrials Fund (PSCI)
 
The industrial sector has been gaining immense popularity of late on a reversal of manufacturing activity led by robust car sales.  Increasing demand, lower interest on auto loans and a resilient economy leading to higher consumer confidence contributed to the big push in auto sales (read: These 3 ETFs Could Soar on Strong Car Sales).
 
Investors seeking to play the rebounding trend in this space could find PSCI an intriguing pick. The fund offers broad exposure to the companies that provide industrial products and services by tracking the S&P SmallCap 600 Capped Industrials Index. The ETF has AUM of $63.1 million while trades in paltry volume. The illiquid nature ensures additional cost for the product beyond the expense ratio of 0.29%.
 
The product has a large basket of 84 securities, which are widely spread across them as each security holds less than 3.6% share. Further, the fund is also widely diversified across various industries including commercial services & supplies, heavy machinery, aerospace & defense and electrical equipment (see more in the Zacks ETF Center).
 
The ETF has returned over 26% in the year-to-date time frame, clearly outpacing the broad sector fund (XLI) and other products by wide margin. The fund currently has a Zacks ETF Rank of 3 or ‘Hold’ rating with Medium risk outlook.
 
Bottom Line
 
These small caps ETFs could be worthwhile in the coming months given the ‘no taper’ decision by the Fed that has boosted the appeal of pint-sized securities having robust growth opportunities. So instead of looking to broad products, it might be a better idea to drill down into these well-positioned sectors for solid returns to close out 2013.
 
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ISHARS-SP MID (IJH): ETF Research Reports
 
ISHARS-R 2000 (IWM): ETF Research Reports
 
PWRSH-SP SC EGY (PSCE): ETF Research Reports
 
PWRSH-SP SC IND (PSCI): ETF Research Reports
 
PWRSH-SP SC MAT (PSCM): ETF Research Reports
 
SPDR-SP 500 TR (SPY): ETF Research Reports
 
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