Last week saw record inflows into small-cap ETFs: why fund managers see opportunity in this ‘undervalued’ segment of the market

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While the supercap chip stocks at the center of the artificial intelligence frenzy continued their record-setting gains in early 2024, there’s also a corner of the market where investors are putting their money: small-cap stocks.

Inflows into small-cap exchange-traded funds hit a record last week, according to strategists at BofA Global Research.

“Small-cap ETFs continue to gain momentum” [in the week to Friday]“We had inflows in 22 of the past 23 weeks, making them the largest weekly inflows in our data history since 2017,” read a team of BofA equity strategists led by Jill Carey Hall, head of U.S. small and mid-cap strategy. stated in a customer note. By MarketWatch on Wednesday.

Carey Hall said the surge in capital inflows was primarily driven by retail investors. It was also a significant shift as Wall Street started betting on a rebound in small-cap stocks after a largely lackluster 2023 as they slowly moved down the market-cap ladder.

Specifically, a select group of small-cap ETFs that track the benchmark Russell 2000 Index RUT and a select group of stocks posted significant net inflows in the week ending Wednesday, according to FactSet data.

The iShares Russell 2000 ETF IWM and Vanguard Small Cap ETF VB had net inflows of $831 million and $870 million, respectively, in the week ending Wednesday. They were among the five funds that attracted the most money out of about 900 ETFs tracked by MarketWatch over the same period, according to FactSet data.

Despite the positive sentiment, small-cap stock positioning remained light last week and valuations remain cheap relative to history, Carey Hall and her team write.

The weak performance of small-cap stocks throughout 2023 has made this part of the stock market relatively undervalued, with the S&P Small-Cap 600 Index SML’s forward price-earnings ratio hovering around 12.33 as of Thursday, while large-cap stocks have been relatively undervalued. The stock has a price-to-earnings ratio of 18.16. -Cap Benchmark S&P500

SPX, according to FactSet data.

The S&P 600 is trading at a 30% discount to the S&P 500, said Will Nasgovitz, chief executive officer of Heartland Advisors and portfolio manager of Heartland Funds’ small- and mid-cap value funds. He said this speaks to the “very attractive valuation setting.” It’s an undervalued and undervalued asset class,” he told MarketWatch over the phone.

Publicly traded companies that typically trade with a market capitalization of approximately $250 million to $2 billion are defined as small-cap stocks. These companies with growth potential can provide huge profits when the economy is growing, but investors are also wary of the reality that the Federal Reserve is unlikely to lower interest rates anytime soon. is difficult to accept and can be very volatile when you are on a roller coaster of interest rates.

As such, record weekly inflows into small-cap stocks neither guarantee nor suggest strong performance in this long-suffering sector of the stock market. The Russell 2000 on Tuesday recorded its eighth consecutive session with a change of at least 1% in either direction, its longest streak since a 10-session streak that ended last March. But so far this week, the index has fallen 1.1%, while the Nasdaq Composite Index has risen 1.7%.

COMP rose, while the S&P 500 rose 1.6% in the same period, according to FactSet.

Perhaps the poor performance of small-cap stocks is a sign that investors are still “sniffing out the weakness in the broader economy,” Nasgovitz said, adding that investors are looking for “a critical self-help catalyst” with low risk-reward. He added that investors may want to consider asset classes that offer more protection. It helps the portfolio “discount” economic weakness.

look: This is the first time in about a year that small-cap stocks have experienced such large price movements. What does that mean for the long-suffering population?

Mid-cap stocks should not be ignored

Sal Esposito, head of ETFs at Zacks Investment Management, said the portfolio management team for the Zacks Small and Mid-Cap ETF SMIZ is currently putting “more emphasis on companies in the middle of the market cap range, which represent about 70% of the market.” “I’m putting it there,” he said. Assets under management are allocated to mid-cap stocks and 30% to small-cap stocks.

“Traditionally, people think of small-cap stocks as high-value investments with volatile share prices, whereas mid-cap stocks are companies that are more stable and can maintain their size and have more potential for growth. “It gives us more exposure to,” Esposito said. MarketWatch said in a phone interview Wednesday.

look: 20 Mid-Cap Stocks Up ~62% in 2024, According to Analysts

Mid-cap stocks typically refer to companies with valuations between $2 billion and $10 billion, but they are often overlooked. In 2023, the S&P Midcap 400 index’s MID lagged the S&P 500 by 10 percentage points and outperformed the small-cap S&P 600 index by less than 1 percentage point, according to FactSet data.

Still, Esposito said he expects his team to adjust SMIZ’s allocation to small- and mid-cap stocks by the end of the year, when there will be a “clearer picture” of the Fed’s interest rate path.

As always, let’s take a look at the top and bottom performing ETFs over the past week through Wednesday, according to FactSet data.

Good stuff…

…and the bad points

New ETF

• Angel Oak Capital Advisors on Tuesday converted two existing mutual funds into ETFs: Angel Oak Mortgage-Backed Securities ETF MBS and Angel Oak High Yield Opportunities ETF AOHY. MBS will be an actively managed pure-play mortgage credit fund, while AOHY aims to invest in high-quality, high-yield corporate bonds and securitized credit assets, according to a company press release.

weekly ETF readings