Micro-Cap ETFs

TM editors’ note: This article discusses a penny stock and/or microcap. Such stocks are easily manipulated; do your own careful due diligence.

Micro-cap stocks generally refer to U.S. publicly traded companies with a market capitalization between $50 million and $500 million. Micro-cap ETFs are exchange-traded funds that focus on this segment of the market. However, most micro-cap indexes target specific deciles of capitalization, or exclude a fixed quantity of larger stocks, so the actual upper bound often approaches $1 billion.

Companies with a market capitalization of less than $50 million are often labeled nano-cap stocks, although some sources will include these smaller stocks within the micro-cap classification.

Because of their sheer numbers and small market values, these stocks often do not receive adequate coverage by Wall Street analysts and brokerage houses. Reduced coverage means less scrutiny, lower liquidity, higher volatility, and increased risk. The SEC publication “Microcap Stock: A Guide for Investors” provides potential investors with information on regulation, trading, and risks of investing in these securities. One of the primary benefits of using ETFs to get exposure to this area of the market is the single-security risk mitigation provided by the diversification achieved from owning hundreds of these stocks.

There are currently four U.S.-listed micro-cap ETFs, and all have been on the market for a minimum of 10 years. Here they are listed in order of fund asset size:

iShares Micro-Cap ETF (IWC), launched 8/17/2005, seeks to track the Russell Microcap Index, which excludes the 2,000 largest U.S.-listed companies by market capitalization. The ETF holds 1,352 stocks with an average market capitalization of $463 million. It has $850 million in assets and an expense ratio of 0.60% (IWC overview).

First Trust Dow Jones Select MicroCap (FDM), launched 9/30/2005, seeks to track the Dow Jones Select Microcap Index, which is designed to represent U.S.-listed micro-cap stocks that are liquid and have strong fundamentals relative to the micro-cap segment as a whole. It covers securities whose market capitalizations fall within a range defined by the bottom two deciles of NYSE stocks. It uses a multifactor screen of fundamentals, momentum, and liquidity to arrive at an ETF holding 515 stocks with an average market capitalization of $515 million. It has $82 million in assets and an expense ratio of 0.60% (FDM overview).