Gain Exposure to Microcaps Through ETFs

NEW YORK ( TheStreet) -- Besides being a deep value investor, I am also a believer in the opportunities available to investors in the micro-cap area of the market.

Companies that fit this description are tiny, typically with market caps below $500 million; sometimes far below. This is an underfollowed area of the markets, primarily because there's often little if any analyst coverage of these companies. Institutions often lack interest because the names are simply too small to make a meaningful impact on an institutional portfolio, plus the stocks in this area of the market often lack liquidity, and may have wide bid/ask spreads.

Opportunities abound for those investors willing to do their own homework on individual names. Don't expect, however to find a great deal of information outside earnings releases, 10Qs and 10Ks, and other assorted news stories.

It's very likely you won't have the "luxury" of an analyst report, because more often than not, there are none available. You may find information on the message boards, but you've got to be wary of anything you read there.

The fact that many micro caps are thinly traded, with prices that are easily moved by any positive or negative sentiment, typically excludes them from garnering meaningful financial media coverage. In many ways as an investor, you are on your own in terms of information. While this presents a challenge for many do-it yourselfers, others don't have the time, patience, or inclination to dig that deep.

If you fall into the latter category, but still want exposure to micro-caps, there are other ways. Perhaps one of the best and cheapest is to use the scatter gun approach that indexing offers.

Most investors are probably unaware that any indices tracking micro-cap stocks even exist. But in fact, Russell has three, the broad Russell Microcap Index, which consists of the smallest 1,000 companies in the small-cap Russell 2000 Index and the next 1,000 securities, plus two sub-indices that focus on growth and value.

I prefer microcap value names, and often look to the Russell Microcap Value Index as the benchmark to judge performance of net/nets (companies trading below net current asset value), and other small value names unearthed by my research.

While it's getting more difficult to find cheap and interesting names in that space these days, performance of the group, as represented by the Russell Microcap Index has been very solid year to date, with the index up 17.3%. If you want small and cheap, it's well represented by this index, and it's 1.1 price to book ratio.

Unfortunately, you can't buy the Russell Microcap Index outright, (or its sub-indices, growth and value) but you can gain exposure through an exchange traded fund, the iShares Russell Microcap Index ( IWC). This ETF provides exposure to the smallest of the small, representing about 3% of the overall market cap of listed U.S. equities. With 1,467 names in the portfolio, the expense ratio at 0.69% is reasonable, if not cheap, considering the nature of typically higher trading costs associated with micro-caps.

As of Sept. 30, the average market cap of IWC's holdings was just $326 million, with the smallest name at just under $6 million, and the largest at $832 million.

You can get exposure to darn near every index through ETFs these days.

At the time of publication the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Jonathan Heller, CFA, is president of KEJ Financial Advisors, his fee-only financial planning company. Jon spent 17 years at Bloomberg Financial Markets in various roles, from 1989 until 2005. He ran Bloomberg's Equity Fundamental Research Department from 1994 until 1998, when he assumed responsibility for Bloomberg's Equity Data Research Department. In 2001, he joined Bloomberg's Publishing group as senior markets editor and writer for Bloomberg Personal Finance Magazine, and an associate editor and contributor for Bloomberg Markets Magazine. In 2005, he joined SEI Investments as director of investment communications within SEI's Investment Management Unit.

Jon is also the founder of the Cheap Stocks Web site, a site dedicated to deep-value investing. He has an undergraduate degree from Grove City College and an MBA from Rider University, where he has also served on the adjunct faculty; he is also a CFA charter holder.

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