Summary
- iShares Micro-Cap ETF is an exchange-traded fund that targets investment in public companies with market caps as low as $400mm.
- This is the most efficient way I have found to include a wide array of very small companies in my portfolio.
- IWC is a Hold for now, but it will be a serious consideration for an upgrade coming out of the equity bear market (whenever that is).
By Rob Isbitts.
To me, iShares Micro-Cap ETF (IWC) is the type of exchange-traded fund, or ETF, that can be used for a very specific purpose. Namely, as one of my longstanding investment rules states, "when taking big shots, do so with a small portion of the portfolio's assets." Micro-cap stocks are, in many cases, solid businesses. But their lack of market capitalization size and the fact that so much market attention is focused on the biggest stocks, makes investing in them akin to owning lottery tickets that don't expire that day or that week. So it follows that if you own over 1,700 of them, some will work out and help your portfolio produce return.
And, in a market environment like the modern one we find ourselves in, an ETF that focuses on the smallest public companies might just land an investor in the highest-potential segment of the entire stock market over the next 3-5 years. Many of the smallest companies' prices were decimated in 2022. That not only makes some of them long-term cheap, it also allows an ETF like IWC to shake out the "weak hands" in micro-cap land, simply by following its usual process.
Also, as I gather a list of ETFs I want to own coming out of the current bear market (at some point), I can't help but notice how IWC nearly doubled the return of the widely-followed Small Cap Value category the last time the stock market had a huge rebound, back in 2020, after the 5-week pandemic induced plunge.
So, while this is not a "core" holding by any means, at a point in the cycle that is finally questioning whether a handful of stocks should be bigger than the rest of the market combined, micro-cap stocks look long-term intriguing to me.
Strategy
IWC aims to track the movement of the Russell Microcap Index. It uses a "representative sampling technique," which means it won't own every stock in the index. But clearly, with 1,700 stocks, it is getting the lion's share of them.
Micro-cap is defined by industry thought leader and index creation icon Russell Investments. As of the last prospectus, about one year ago, the market cap range considered was anywhere from $4 million to $4.6 billion. According to IWC's prospectus, "the underlying index consists of approximately the 1,000 smallest issuers in the Russell 3000® Index plus the next 1,000 smallest issuers in the equity universe as determined by Russell."
ETF Grades
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Offense/Defense: Offense
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Segment: Thematic
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Sub-Segment: Small Cap
Technical Ratings
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Short-Term (next 3 months): C
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Long-Term (next 12 months): B
Rating scale: A = Excellent, B = Good, C = Fair, D = Weak, F = Poor
For a detailed description of MII's proprietary technical rating system, see disclosures at bottom of this report.
Holding Analysis
5 of the 11 S&P sectors (Utilities, Communication, Basic Materials and Consumer Defensive and REITs) combine to make up just 13% of assets under management, or AUM. That means that there is a decided concentration here in terms of sector exposure. Indeed, Healthcare alone accounts for 28%, and another 19% is made up of Financial stocks. That's about half of IWC right there.
Strengths
One of IWC's greatest uses is for investors who understand and appreciate the appeal of investing in very small public companies, but do not want to take the time and effort to figure out which ones to buy. After all, Microcap stocks represent less than 3% of the total US stock market.
So, with more than 1,700 companies accounting for that small a portion of the total stock market, trying to get access to them in a way that is efficient and doesn't come laden with single-stock risk is difficult. Except for the fact that IWC has been around since 2005, and is run by the biggest ETF provider, iShares. So, if anyone can manage the intricacies of owning so many small stocks in a single ETF vehicle, it is them.
IWC turns over its holdings at a rate of about 44% a year, which means that there is a continued updating and cleanup, which is helpful in this small, less liquid part of the stock market. This is a $1 Billion ETF, with average daily trading volume of around $6mm, so it is sufficiently liquid for many investors to buy or sell when they wish.
Weaknesses
One reason for that high turnover rate is that some stocks "graduate" from the micro-cap world to the traditional small cap segment. That could mean that investors get to participate in the early stages of the rise of a super-stock, but then exit just as things are getting interesting. That said, more diligent investors can look at when IWC reconstitutes its portfolio, and scout the stocks it exits to see which ones are the potential future breakouts. Chances are, those will be among the larger holdings in IWC when the ETF nears its rebalancing dates.
Opportunities
Technology stocks are just 11% of IWC's portfolio, which I think is a great aspect of this ETF. Investors have plenty of choices for where to access tech exposure. There's no reason to combine the volatility of that sector with a micro-cap ETF. Now, that doesn't mean it won't happen at some point. But it is not the case today.
With an average current market capitalization of under $600mm, IWC truly provides a gateway to the micro-cap market. You won't find too many, if any, names of companies you recognize in the IWC holdings list, unless you happen to work or know people who work for those companies. Or, if you are already a small stock researcher.
Threats
This is equity investing, and this is micro-cap investing. That means that volatility comes with the territory. With a 47% drawdown in its history, IWC should not be confused with risk-managed investing, other than the vast diversification and lack of single-stock concentration in this ETF.
Conclusions
ETF Quality Opinion
iShares Micro-Cap ETF is a must-follow for me. I really have not found anything that targets that part of the market like this ETF does (but I welcome any helpful hints of where to look!). I am not typically a fan of ETFs that hold more than 100 stocks, much less 1,700+. But there's good reason for that with IWC, and I think it might just be a leader coming out of the bear market, whenever that may occur.
ETF Investment Opinion
iShares Micro-Cap ETF is a Hold for me now, because there are very few equity ETFs I think can make sustainable returns during the current bear market. But that phase will end, hopefully with valuations at screaming-low levels. At that point, IWC will likely be on my list for ETFs to consider. It will never be a huge, dominant portfolio allocation, but it doesn't have to be to add value to my broader ETF portfolio.
Modern Income Investor's proprietary technical rating system was created by the firm's founder, Rob Isbitts, a chartist for more than 40 years. The ratings emphasize risk-management, and the belief that while any investment can appreciate in price at any time, each investment carries a different level of potential for major loss. The balance of reward and risk is calculated each night for thousands of securities, using a formula that analyzes price trend, strength of that trend and key price levels. It analyzes data over multiple time frames to produce a short-term rating (looking 3 months out) and a long-term rating (looking 12 months out).
For further details see:
IWC: Efficient, Potentially High-Return Way To Access The Smallest Stocks