FDM First Trust Dow Jones Select Microcap Index Fund

With 2011 turning out to be a mixed year to say the least for the markets, many investors are eagerly looking forward to the new year and (hopefully) better returns in the equity world. Luckily for investors, January is usually a pretty strong month for stocks, suggesting that many could see large gains to start the year if historical trends hold true once again. This is largely due to what is popularly known as the ‘January Effect’. 

This idea states that stock prices generally have a rough or so-so December and then surge higher in January thanks to investors redeploying their capital. This phenomenon could be due to several reasons, many of which are based on how investors behave around the end of the year. Primarily, tax-loss selling in December can often push down stock prices in the month as investors sell some of their losers in order to harvest losses come tax time. These investors then wait until the new year to put the money to work in the market, boosting prices in turn. This effect can be especially potent for small cap stocks as this asset class has a history of starting off the year on a high note (read ETFs vs. Mutual Funds).

However, thanks to widespread knowledge of the phenomenon, the impact of this has been muted in recent years while the shift to long-term retirement plans—which have no need for end of year tax selling—has also reduced the effect across the market. Fortunately, the effect still can live on in some corners of the market and especially so in the smallest of the small, the micro cap ETF world (read Three Outperforming Active ETFs).

These securities have proven to exceed their large cap brethren primarily in January and not so much in the rest of the year. In fact, recent research suggests that bottom decile of stocks by market cap have outperformed the largest tenth by 700 basis points in January but have matched the return of the space in the rest of the year. This suggests that January is truly the time to get in on micro cap securities, assuming that these historical figures hold true this year as well. Should this be the case, investors should take a closer look at some of the micro cap ETFs on the market which could offer up excellent exposure to this potentially potent stock market anomaly:

iShares Russell Micro Cap Index Fund (IWC)

This ETF tracks the Russell Microcap Index which is a benchmark that consists of ultra small companies based in the U.S. The average market capitalization of the fund is just under a quarter billion while just 4% of assets are classified as small caps as opposed to micro cap securities. The fund currently consists of close to 1,400 securities and it puts just 3.3% of assets to the top ten holdings. Financials take the top spot from a sector perspective at close to 27.2% while health care (17.4%) and technology (13.7%) round out the top three. The fund lost 10.4% last year but has rebounded strongly over the past three months gaining 14.1% in the period (read Three Low Beta Sector ETFs).

First Trust Dow Jones Select Micro Cap Index Fund (FDM)

This fund from Illinois-based First Trust tracks the Dow Jones Select Microcap index which follows firms that are in the bottom two deciles of NYSE stocks. The managers also look to take a more ‘active’ approach in their security selection process, picking firms based on market capitalization, trading volume, and financial indicators that include trailing price/earnings ratio, trailing price/sales ratio, per-share profit change for the previous quarter, operating profit margin and six-month total return. As a result, the fund has far fewer securities than its counterparts on the list with just 239 firms in total (see Avoid Turmoil With The Community Bank ETF).

Nevertheless, the fund still has a heavy concentration in financials (24.1%) while industrials (20.5%) and technology (14.7%) firms round out the top three sectors. However, FDM does have a heavier concentration in its top ten holdings putting 7.8% of the total assets in this group and it does have a high turnover level with the rate coming in at 86% on a yearly basis. Thanks in part to this, the fund has lost less than IWC in 2011, falling by 8.9% over the course of the year. Yet, the product also has surged higher in the past three months as well, gaining 17.7% over that smaller time period.

Wilshire Micro Cap ETF (WMCR)

The last entrant on the list comes from Guggenheim and its WMCR which tracks the Wilshire Micro Cap Index. With this benchmark, the fund tracks close to 830 securities and has the lowest expense ratio of the group coming in at 50 basis points a year. The fund puts 7.2% of its assets in the top ten holdings and has just 1.6% of the assets outside of the micro cap space. This fund also has a heavy concentration in financials (23.7%), although health care and tech combine to make up another 35% of the portfolio as well. In terms of performance, the fund has underperformed despite its lower cost; losing 20.4% on the year and gaining just 4.7% in the past three month period (see Three Worst Performing ETFs of 2011).

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