Market Overview

A Fantastic Fundamental Small-Cap ETF

A Fantastic Fundamental Small-Cap ETF

Weighting exchange traded funds by various investment factors isn't confined to large-cap funds. Some small-cap ETFs employ alternatives to weighting my market capitalization with historical data suggesting the combination of small size and value can be rewarding with smaller stocks.

The Schwab Fundamental U.S. Small Company Index ETF (NYSE: FNDA) is an example of a fund that breaks from the norm among small-cap ETFs.

What Happened

FNDA, which recently turned five years old, targets the Russell RAFI- US Small Company Index. That benchmark “measures the performance of the small company size segment by fundamental overall company scores- which are created using as the universe the companies included in the Russell 3000 Index,” according to Schwab.

Fundamentals used by FNDA's underlying index include size, revenue, cash flow, dividends and share repurchases. That gives the Schwab ETF a value feel although it is classified as a small-cap blend fund.

Why It's Important

While FNDA isn't explicitly considered a value fund, it does take steps to ensure its roster is not littered with richly valued stocks.

“When it rebalances each quarter, the fund trims positions in stocks that have become more expensive relative to peers and increases its exposure to those that have become cheaper in the past year,” said Morningstar in a recent note. “These disciplined bets against the market should give the fund an edge against its market-cap-weighted value index peers if and when valuations mean-revert. However, this approach can also increase the fund's exposure to stocks with deteriorating fundamentals. This is because the metrics that determine the weightings of the fund's constituents are backward-looking and are usually slower to detect souring prospects than market prices. To reduce the market-impact cost of rebalancing and the risk of poor timing, the fund refreshes a different fourth of its portfolio each quarter.”

FNDA holds nearly 900 stocks with over 38 percent of the fund's components hailing from the industrial and consumer discretionary sectors. Financial services and technology names combine for 25.50 percent of the fund's roster.

What's Next

Smart beta strategies such as FNDA aren't guaranteed to beat cap-weighted benchmarks across all time frames. Year-to-date, the Schwab ETF is up more than 7 percent, a disadvantaged of about 360 basis points against the Russell 2000 Index. However, FNDA's long-term returns are solid.

“From its inception in August 2013 through August 2018, the fund outpaced the Russell 2000 Value Index by 1.39 percentage points annualized,” said Morningstar. “However, it slightly lagged the Russell 2000 Index by 7 basis points annually, owing to a stretch of underperformance in the past year, which stemmed partially from its underweighting of the healthcare sector.”

Morningstar has a Bronze rating on FNDA.

Related Links:

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Latest Ratings for FNDA

Sep 2015JP MorganUpgradesNeutralOverweight

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