Small-cap ETFs see surge in inflows

Trade reform, trade tiffs and strong dollar are all benefiting domestically oriented small-caps

Jun 5, 2018 @ 11:01 am

By Bloomberg News

ETF investors haven't been this "America first" since Donald Trump won the presidential election — at least if flows to small-capitalization companies are any guide.

Last month, roughly $7.5 billion poured into exchange-traded funds focused on small-cap stocks, the most since November 2016, according to data compiled by Bloomberg Intelligence.

What's driving the activity? A confluence of goodies for domestically oriented companies, as tax overhaul benefits kick in amid trade tiffs and a stronger U.S. dollar, all of which makes them more attractive than big international companies.

"I think there's just been this desire to kind of hunker down in more domestically oriented companies that are more immune to the trade disputes," said Liz Ann Sonders, chief investment strategist at Charles Schwab & Co.

(More: Some small-caps win in the long term — but which ones?)

The flows are following strong performances by small-cap stocks. The Russell 2000 Index gained 6% in May, the best month for the gauge since September. What's more, it outperformed both the Russell Midcap Index and the Russell 1000 Index for the third straight month, its longest winning streak in almost two years, according to BofA Merrill Lynch Global Research.

By one measure, small-caps are outpacing their larger brethren by the most in 16 years. The three-month premium on the S&P Small Cap 600 Index over the S&P 500 Index is at a level not seen since May 2002, according to S&P Dow Jones Indices.

But some investors are concerned that the strong performance won't continue.

"I think investors may be sort of cheering that tax-related benefit to small-caps without digesting the offset of that to some degree, which is that they're more indebted and they get hurt a bit more on that interest expensing piece," Ms. Sonders said.

Matt Maley, an equity strategist at Miller Tabak & Co., added that small-cap stocks could run out of steam when the rising dollar starts to slow down.

"Since the dollar has been a big catalyst for the out-performance of the Russell, we wouldn't be chasing the small caps at these lofty levels over the very-short-term," he wrote to clients last week. "Over the near term, we are looking for a period of underperformance in the Russell 2000."

(More: Top 10 small-cap funds this year)


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