Small-Cap ETFs Have Big Potential, Says BofA

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There are many reasons for investors to consider exchange-traded funds made up of smaller companies, according to recent research from BofA, which also makes some recommendations on which funds to consider. Tip: Small is also better than large when it comes to fees. Among other things, the BofA team of analysts, led by Jared Woodard, is aware that US economic growth is likely to increase over the next two years (their economists forecast 7% GDP growth in 2021 ), which benefits the earnings and performance of small caps more than larger companies, in part thanks to their greater exposure to “repressed demand for service spending,” they write.

Smaller companies are also major beneficiaries of Washington‘s Blue Wave of fiscal stimulus, historically performing better than large caps during the middle of the business cycle, which is where BofA analysts calculate we are now. They are more likely to benefit from an increase in capex and their valuations are more attractive than those of large-cap companies, the analyst team wrote. See: Here are the ETFs to Help You Invest in Biden‘s Infrastructure Plan Analysts Recommend the Vanguard Small-Cap Growth VBK ETF, + 1.08%, the Vanguard Small-Cap Value ETF VBR, + 0.13%, and the Vanguard ETF Russell 2000 ETF VTWO, + 0.75%, taking into account fundamentals, technical aspects and efficiency. These funds have much lower expense ratios of 0.07%, 0.07% and 0.10%, respectively, than many of their peers, as well as tighter margins. However, BofA has a caveat when considering investing: “Small caps have given up their lead for the year to date, and we also recognize that there may be more risk in the short term,” they write. “Our work suggests that small cap has outperformed large cap only ~ 40% of the time in April versus> 60% of the time in May and June.” Still, there has recently been a flood of money flowing into small-cap ETFs, they write, “in all major client groups, but led by retail, who, according to our recent GWIM survey, are increasingly optimistic in the size segment, both medium and long term. Meanwhile, active funds remain highly underweight in small caps: small caps have accounted for a declining share of multi-cap fund holdings, and Large Cap Active Managers Are Underweight Smaller Equities vs. Overweight Mega Cap ”.

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The graph above, from the BofA research note, shows that approximately $ 35 billion has been invested in small-cap funds, which include ETFs and mutual funds. That’s dwarfed by the roughly $ 100 billion of exits since 2013, when small caps began their secular underperforming cycle. Read: ‘Goldilocks’ Funds? Mid-cap ETFs may be about to have their moment