Weighing the Thrills and Spills of Small ETFs

Photograph by Colin Anderson/Getty Images Close

Photograph by Colin Anderson/Getty Images


Photograph by Colin Anderson/Getty Images

Some things just seem more dangerous -- and perhaps more thrilling -- when they're small. Like cars. And planes. And, for some investors, exchange-traded funds.

Currently, 33 of the 50 best-performing ETFs of 2013 are funds that began the year with less than $100 million in assets. The market-beating performance of these smaller ETFs has attracted $1.2 billion in new cash this year, compared to $3.8 billion pulled in by the 17 bigger ETFs.

While these up-and-comers are having their day in the sun, many experienced growing pains that potential investors in small ETFs should be aware of. Buying an ETF that has less than $100 million in assets and has rocketed up the charts is risky, and not just because you're buying momentum. Typically, the smaller the ETF, the less it trades and the wider the bid/ask spread, meaning that the prices at which you can buy or sell are pretty far apart. To mitigate this, investors can use a limit order instead of a market order when buying or selling a small ETF, or any ETF.

For many of these niche products, one year in the sun is what they need to become more viable to a wider range of investors. Their Catch-22 is that for them to be perceived as less risky money needs to flow in and boost volume, shrink spreads and remove the risk that the ETF will be closed for lack of assets. If an ETF does decide to close, it notifies investors at least 30 days in advance so they can sell their shares. Investors who purposely or unknowingly hold on to the ETF until the day of liquidation get the cash equivalent of the value of the assets at the time of sale -- which could be either more or less depending on how the ETF's sector is doing.

Here's a look at some of the more dramatic rags-to-riches stories of 2013. Each of these ETFs is up more than 30 percent and has broken through the all-important $100 million asset level. Potential buyers should be aware that, as the ads say, past performance is not indicative of the future.

1. Guggenheim Spin-Off ETF (CSD)

CSD, which tracks recently spun-off companies, has gone from $67 million to $280 million in assets, a 317 percent jump. It tries to capture the performance of companies in their growth spurt between six months and thirty months of being spun off. Half of CSD is in small-cap stocks; the other half is in mid- and large-cap stocks.

2. PowerShares Dynamic Media Portfolio (PBS)

Assets in PBS have risen from $86 million to $226 million, a 162 percent jump. Both traditional media and social media stocks have been on fire this year. This ETF gives a mixture of both with large allocations to Time Warner Inc. (TWX) and CBS Corp. (CBS), as well as LinkedIn Corp. (LNKD) and Yahoo! Inc. (YHOO). It's weighted based on a stock's fundamentals, such as its earnings and price momentum, as opposed to market capitalization.

3. DB X-Trackers MSCI Japan Hedged Equity Fund (DBJP)

DBJP has grown from $5 million to $157 million, a 3,040 percent rise in assets. It lives in the long shadow cast by the WisdomTree Japan Hedged ETF (DXJ), which has grown to $10.6 billion since its 2006 inception and which also hedges out yen exposure. DBJP'S 33 percent return so far this year is 5.6 percent more than that of DXJ. That's because DBJP holds three times more financial stocks, which have done very well this year, than DXJ.

4. PowerShares DWA SmallCap Technical Leaders Portfolio (DWAS)

DWAS has gone from $13 million to $302 million, a 2,223 percent jump. It tracks 200 small-cap stocks picked from a universe of 2,000 purely for their relative performance strength using technical analysis. This is a quasi-active ETF that is beating its competition, the iShares Russell 2000, by 10 percent over the past year.

5. iShares U.S. Insurance ETF (IAK)

IAK's assets have jumped from $81 million to $152 million, an 87 percent jump. It tracks a collection of insurance company stocks, which have been outpacing the broader financial sector this year. A recent S&P Capital IQ research note said that rising interest rates would benefit insurance companies and help IAK rise beyond its 33 percent return for the year to date.

Other niche ETFs that have broken through the $100 million barrier this year on 30 percent or above performance include the Guggenheim Solar ETF (TAN), iShares Aerospace & Defense ETF (ITA), PowerShares Nasdaq Internet Portfolio (PNQI), iShares Broker-Dealers ETF (IAI) and the PowerShares Dynamic Food & Beverage Portfolio (PBJ).

It's reasonable to worry that money chasing after hot performance could cause fast-growing ETFs to crash and burn. That's why these ETFs are for speculative investors. Who like roadsters. And Cessnas.

Eric Balchunas is an exchange-traded-fund analyst at Bloomberg. More ETF data is available here, and weekly ETF podcasts can be found here.

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