About One Small-Cap ETF Offering De-Facto Broad High-Beta Portfolio Diversification

September 20, 2021

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About One Small-Cap ETF Offering De-Facto Broad High-Beta Portfolio Diversification

As major U.S. stock benchmarks have been increasingly underperforming lately, many investors seek alternative venues beyond safe-haven assets to beef up their portfolio yields. For example, Vanguard Total Stock Market Index Fund ETF Shares (VTI) fell 0.5%, marking the second consecutive week of declines on evaporating trade volume.

The iShares Core S&P Small-Cap ETF (IJR) is an exchange-traded fund that enables U.S. investors to gain direct exposure to U.S. small-cap stocks. Traditionally, small-cap stocks are unappealing unless they show some kind of "small-cap premium", i.e., they are at higher risk and lower liquidity and for that purpose need to offer greater returns. In reality, often it is the case that the "higher beta" (relative to the benchmark volatility) creates that sought portfolio momentum. For IJR it is a pretty decent 1.28x at the time of writing. The risk is realized exclusively on the downside, which must be hedged elsewhere outside the small-cap jurisdiction. Having said that, we must note that IJR has shown the ability to outperform SPY over the longer run.

Three of IJR's underlying holdings with notable upsides to their fair prices are Cytokinetics (CYTK), QuinStreet (QNST), and Vista Outdoor ( VSTO). Although CYTK has traded at a recent price of $32.84/share, the average price target is 43% higher at $47.00/share. Similarly, QNST has over 41% upside from the recent share price of $18.07 if the average analyst target price of $25.50/share is reached, and analysts on average are expecting VSTO to reach a target price of $53.50/share, which is 26.36% above the recent price of $42.34.

The top 10 holdings represent 6.6% of the fund, but the main advantage of this ETF is that its holdings are very much fractured across the board. Thus, on top of the list is a company called Omnicell Inc (OMCL) but this occupying just 0.68% of its portfolio composition. Averaging share of one holding by total reported 674 holdings, we would find an estimated base rate of 0.15%. While 0.68% is 4.5x larger than the base rate, clearly there is no concentration risk here, especially as compared to typical S&P 500 funds that are market-cap weighted and generate large levels of concentration among tech names thereby virtually tightly connected to the underlying index performance (and misperformance for the purpose of this article). This makes IJR comparatively far more diversified and representing a high-beta macro bet rather than a bet on a particular sector (or sectors), which makes it a nice-looking broad portfolio diversification vehicle.