More Profit Potential with Micro-Cap ETFs

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FreeVector-Stock-ExchangeAs we’ve previously noted, exchange traded funds (ETFs) that track micro-cap stocks can be a useful tool for the investor that is looking to get exposure to small stocks, but who doesn’t want to be involved with all the burdensome leg-work of stock-picking in the micro-cap universe. We’ve highlighted two promising microcap ETFs thus far, the PowerShares Zacks Micro Cap ETF (NYSE: PZI) and the iShares Russell Microcap Index Fund (NYSE: IWC), which happens to be the oldest and largest micro-cap ETF listed in the U.S.

Check Expense Ratios

The good news is the choices among micro-cap ETFs don’t end with the iShares Russell Microcap Index Fund or the PowerShares Zacks Micro Cap ETF. Another option to consider is the First Trust Dow Jones Select MicroCap Index Fund (NYSE: FDM) and there’s one reason to do so right off the bat: Expenses.

As avid ETF investors know, an ETF’s expense ratio has a profound impact on your overall returns and that alone makes the First Trust Dow Jones Select MicroCap ETF a valid option among micro-cap funds. Consider that the iShares Russell Microcap Index Fund has an expense ratio of 0.67% and the PowerShares offering has fees of 0.7%. Well, FDM beats them both with an expense ratio of 0.6%.

FDM, which debuted in 2005, has over $54.3 million in assets under management, making the ETF a fair bit larger than PZI, but much smaller the IWC. But even with being larger than PZI and cheaper than IWC, the First Trust Dow Jones Select MicroCap ETF is overshadowed in this arena. That probably shouldn’t be the case because the in the past year, FDM has narrowly outperformed IWC and sharply outperformed the PowerShares fund.

Sector Diversification is Limited

FDM is home to nearly 240 stocks and five sectors – financials, industrials, consumer discretionary, health care and technology receive double-digit allocations in the ETF. If you’re looking for a micro-cap ETF with exposure to conservative sectors like consumer staples and utilities, FDM isn’t the best bet as those two groups combine for a weight of less than 3% in the fund.

Following the rough road traveled by bank stocks in 2011, it might be a turn-off to some to learn FDM devotes over 24% of its weight to financials, but some micro-cap bank stocks offer real promise and have been easily outperforming their large-cap brethren for several years now. Put another way, some experts would argue, if you’re looking for growth among bank stocks, it’s going to be found with small- and micro-cap names and FDM certainly helps alleviate the burden of trying to find the best individual names among obscure bank stocks.

The smallest company currently included in FDM has a market value of $99 million while the largest has a market cap of $722 million. Overall, the ETF has a median market cap of $346 million. FDM, which tracks the First Trust Dow Jones Select MicroCap Index, trades with a P/E ratio around12 and has gotten off to a great start this year gaining 12.6%.

FDM cleared resistance at $21 mid-month January and then another resistance level at $22.50 on 2/3. It could easily tack on another $3-$5, maybe $7 from here, but be advised no options currently trade on this fund.

Posted by Micro Trader