Capitalize on This Small-Cap ETF’s Key Differences

Investing in exchange-traded funds (“ETFs”) doesn’t need to be boring…

Even within investing categories, you can find meaningful differences.

The approach to capitalizing on these differences is similar to how we hunt for 10-bagger opportunities. And as I explained recently, the process is simple to understand…

  1. Start with an open mind.
  2. Use a sensible investment approach.
  3. Be willing to explore obscure corners of the ETF universe.

In a sense, small-cap value stocks are obscure by definition…

After all, most folks think “growth” when small caps are mentioned. And frankly, that makes sense. Small caps typically either grow into larger companies or go bust.

But right now, the Power Gauge is alerting us to an unusual opportunity in this space…

It’s flashing a lot of “bullish” or better marks for small-cap value stocks. And as you’ll see today, a little extra digging can help us spot the best opportunities in the bunch…

These days, the Power Gauge increasingly favors value. It cares more about quality, too. And I’ve noticed a tilt toward small caps.

Obviously, we could screen for individual stocks with all three qualities. But a lot of folks like the “one click” ease of ETFs. And fortunately, several ETFs fit these criteria today…

The giant iShares Russell 2000 Value Fund (IWN) is one of the most popular small-cap ETFs, for example. And the Power Gauge ranks IWN as “very bullish” today.

However, that ETF’s “Power Bar” ratio is underwhelming. IWN currently holds 410 favorably ranked stocks. And it holds 224 unfavorably ranked positions.

The ratio of IWN’s favorably-to-unfavorably-ranked stocks (1.8) works out to a “neutral” rank compared with other U.S. ETFs. It’s also “neutral” on a portfolio-weighted basis.

But digging further, I noticed the Royce Quant Small-Cap Quality Value Fund (SQLV)…

The Power Gauge also ranks this ETF as “very bullish” today. And more importantly, the system currently views its holdings much more favorably than IWN’s holdings…

SQLV’s Power Bar ratio is 3.5 today. It has 91 favorably ranked stocks and only 26 unfavorably ranked stocks. And compared with other U.S. ETFs, it’s “bullish” ranked.

If you want another key difference, SQLV starts with a big advantage over IWN as well…

SQLV holds 235 stocks with Power Gauge rankings. Meanwhile, IWN currently owns shares of 1,320 ranked stocks. That’s significant for a simple reason…

It’s hard to gain an edge while owning such a big portion of the total eligible universe (about 2,000 stocks). In other words, IWN basically just tracks the entire small-cap market.

Now, before we wrap up, I need to address another aspect of searching for the best opportunities in obscure corners like small-cap value. These ETFs can be incredibly small.

For example, SQLV’s assets under management only total about $19 million.

But importantly, the liquidity of an ETF is based on the liquidity of the securities it owns. It isn’t based on the size of its portfolio. So that isn’t a huge concern for us as investors.

In the end, we’ve entered a new world in 2022. We’re now in a “stock picker’s market.”

We can no longer count on falling interest rates to shield us from bad investment choices. And stock selection is far too important to rely on generic outdated ideas of value investing.

For this new world, I prefer SQLV. And the Power Gauge helps us see why.

Good investing,

Marc Gerstein

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