Small-Cap ETFs Holding Their Ground

The Standard & Poor's 500 index may be down more than 11% year to date, but small-cap exchange-traded funds have been holding their ground.

The respective year-to-date declines of 2.5%, 1.7% and 0.7% turned in by the Vanguard Small Cap ETF (VB Quote), the iShares Russell 2000 Index(IWM Quote), and the iShares S&P SmallCap 600 Index (IJR Quote) have left these funds in far better standing than the broader markets and most other ETFs.

Only 17.4% of the 814 ETFs tracked by Morningstar so far in 2008 have been able to make it into positive territory.

The past several weeks have been particularly favorable for these small-cap ETFs. Since July 15, these three small-cap ETFs have surged 10.6%, 12.1%, and 11.6%, respectively. The S&P 500 has improved only 4.6% over the same time period. It might be too early to tell, but if the market begins to break out of its prolonged slump these funds could have even more upside. "We have always looked at small-cap stocks as being the beneficiaries of early-stage economic recoveries," says Larry Glazer, a managing director for Mayflower Advisors. "The challenge is to try to determine if that is where we are headed."

Some of the holdings of these small-cap ETFs include companies such as Alpha Natural Resources (ANR Quote), Ansys(ANSS Quote), Energy Conversion Devices(ENER Quote), and Walter Industries(WLT Quote).

Small-cap ETFs carry some distinct benefits as well as risks when compared with ETFs that are dominated by large-cap names. "Small caps have far less currency exposure," Glazer says. "They are also significant beneficiaries in times of declining energy prices."

The recent turmoil in the credit markets could make for a hangover effect that could hit hard many of the companies that make up these small-cap ETFs. "One concern that I have in general for small-cap companies is that they might not have access to capital like large caps because of the credit crunch we are in," says Glazer. "We also don't think that small-caps are much of a relative bargain in this market."