Two Great Bets on Small Caps

12/14/2010 2:54 pm EST

Focus: ETFS

Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

One ETF is loaded with Canadian miners and drillers, while Vanguard offers a cheap way to play the field, writes Richard Lehmann of the Forbes /ISA Closed-End Fund & ETF Report.

The sequential financial crisis in Europe seems destined to go on for quite a while. Every time the dollar begins to look weak, new concerns over European financial health strengthen it again. The country of the month has moved from Greece to Ireland and now Portugal, next month probably Spain followed by Italy. If the wave ever hits Germany, it’s all over.

We prefer to sidestep the entire region for now and look for a stable currency in a resource-rich environment. Canada seems to fit the bill.

Profit from Northern Exposure
The IQ Canada Small Cap ETF (NYSEArca: CNDA) invests in the small cap companies domiciled in Canada. This gives the investor two ways to enhance performance.

One is the currency. Right now, the Canadian dollar is worth almost the same as the US dollar, extending its recent gains against the greenback. The other effect of a weak US dollar is a rise in the prices of natural resources such as oil, gold, and other metals, thus giving investors a double dose of performance when the dollar is down.

The fund’s largest holdings are in the industrial materials sector at 56.4% of assets, followed by energy at 17.7% and financials at 10.6%. It does not pay a regular dividend, but has a decent expense ratio for a fund of its kind at 0.69%.

A 25% Return for a 0.13% Fee
Investors seeking broader exposure to smaller caps south of the 49th parallel might consider the Vanguard Extended Market ETF (NYSEArca: VXF), which invests in a broadly diversified index of stocks of small and medium-size US companies. [It mirrors the Standard & Poor’s Completion Index, which consists of the approximately 4,000-plus stocks listed on the main US exchanges that are not part of the S&P 500—Editor.]

We choose this fund because its low expense ratio of .13% is among the lowest of all ETF’s and is the lowest in its portion of the market. The fund currently yields 1.05%.

No single position is greater than 0.5% of total holdings, so the fund is highly diversified. Like most index funds, it is passively managed and has a low turnover ratio of 17% compared with 58.7% for other funds in this market segment. The fund has gained 25.4% year-to-date.

[Jim Oberweis recently picked seven growth-oriented small caps poised to outperform next year, while Russel Kinnel has profiled a little-known small-cap fund that’s consistently outperformed—Editor.]

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