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Small-cap growth stocks can lead to significant outperformance over time. While the selection of ETFs is comparatively thin, there are several choices for each kind of investor. Healthcare and financials tend to make up the largest positions in these ETFs. I’m primarily a value investor, meaning I look for stocks that the market hasn’t discovered yet or that are out of favor for some reason. So why own a small-cap growth ETF? My favorite asset class is small-cap stocks. That’s because it is where you are most likely to find interesting little companies that other people pass over. They may do something unusual or exotic, and that can scare away most investors. Most of all, however, it is where you are most likely to find the stocks that will outperform the market over the long term. That’s just pure common sense – small companies have much more room to grow to become large companies than large companies have to become, well, even larger. You need a small-cap growth ETF to balance out value with growth, because owning a broadly diversified portfolio is essential. Sector outperformance occurs all the time, and the more diversification you have, the better. If you don’t have diversification, then you risk seeing your overall portfolio fall more in bad times by having your money overly concentrated. A small-cap growth ETF also provides exposure to those fast-growing companies that deliver outsized returns. The small-cap sector can provide outsized returns as well, so the combination of stocks that are growing quickly and have the furthest to run because they are small is what gets me interested in this sector. I’ve been hunting down 3 small-cap growth ETFs to share with aggressive investors, conservative investors, and the average investor. So when it comes to small-cap ETFs, I really like to take my time finding the ones that may suit different investors. There are a lot of approaches to small-cap investing, but here are the three small-cap growth ETFs that I think might be most interesting to the average Joe investor, aggressive investor and conservative investor. The best small-cap growth ETF for the conservative investor is the First Trust Small Cap Growth AlphaDEX ETF (NYSEARCA: FYC ). This is a quasi-actively managed fund. It first narrows down the S&P SmallCap 600 Growth Index by selecting stocks based on growth factors including 3-, 6- and 12-month price appreciation, and sales to price and 1-year sales growth. Value stocks are screened out, and of the growth stocks that remain, the top 75% are selected, which leaves 188 stocks. Those are then divided into quintiles based on their growth rankings and the top-ranked quintiles receive a higher weight within the index. The stocks are equally weighted within each quintile. The index is reconstituted and rebalanced quarterly. The resulting sector breakdown is 28% healthcare, 18% consumer discretionary, 17% financials, 15% IT, 14% industrials, 3.5% consumer staples and a smattering of others. Its P/E ratio averages 23, and has returned a solid 16.64% in the past 3 years. With a beta of 1.06, that return has only come with 6% more volatility than the overall market. The risk-adjusted return is reflected in an impressive Sharpe Ratio of 1.24. The average Joe may consider the iShares Russell 2000 Growth ETF (NYSEARCA: IWO ) is a simple, no-frills ETF. It actually only has 1,158 holdings, in which the fund uses a representative sampling indexing approach, meaning it takes those companies that represent the entire index of 2,000 stocks. It has a reasonable average P/E ratio for a small-cap growth funds, at 26.82, and yet has a beta of only 0.95, meaning it is 5% less volatile than the market. Its yield is 0.68%, which is a pleasant bonus as far as far as I’m concerned since so few small-cap stocks have any yield. That yield covers the 0.25% expense ratio as well. The sector breakdown includes 28% healthcare, 1% energy, 12% industrials, 18% consumer discretionary, 23% IT, 7% financials and 3% consumer staples. Finally, aggressive investors should look at the SPDR S&P 600 Small Cap Growth ETF (NYSEARCA: SLYG ) , which is just about the best-performing fund in this asset class, including better than the S&P 500 index from before the financial crisis to the present. It is like the AlphaDEX fund, but it doesn’t trim out other stocks from the index. It keeps all the growth stocks. The fund holds 355 stocks, spread into 24% financials, 18% healthcare, 17% consumer discretionary, 17% IT, 4% materials, and a bit of other sectors in small amounts. It is the fact that it isn’t terribly diversified in terms of sector allocation that makes it more aggressive. This is somewhat balanced by the fact that the PE ratio is lower than the other choices, at 19.5. Its 1.19% yield pays for the 0.15% expense ratio, giving you that extra 100bps in yield to goose your returns. Its 3-year return is 19.54%, making its more aggressive approach pay off. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Scalper1 News
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