Small-Cap ETFs Climb As Volatility Ebbs

Small-cap stocks and the related exchange traded funds have recently been outperforming large-cap equivalents by significant margins. Over the past 90 days, the Russell 2000 Index is up 6.6 percent compared to just 1.6 percent for the large-cap S&P 500.

One of the rubs with small-caps is that they're usually more volatile than larger stocks, but the volatility differential between the two is narrowing.

What Happened

The three-year standard deviation on the iShares Russell 2000 ETF IWM, the largest ETF dedicated to smaller stocks, is 14.05 percent, according to issuer data. By comparison, the three-year standard deviation on the iShares Core S&P 500 ETF IVV is 10.30 percent.

“In a small cap-led US equity market where the Russell 2000 Index has risen 9.6 percent relative to a 5.2 percent rise for the US large cap Russell 1000 Index as of June 11, the year-to-date volatility differential between small and large cap US stocks is at an all-time low, according to new research from Cboe Global Markets (Cboe) and FTSE Russel,” according index provider FTSE Russell.

Why It's Important

With IWM offering significant outperformance of diversified large-cap ETFs, it's notable that the volatility gap is declining.

“A recent study by Cboe has found that the 'small cap premium,' or the difference between perceived US small cap volatility and US large cap volatility as reflected by average daily closing prices of the Cboe Russell 2000 Volatility Index (RVX) and the Cboe Volatility Index (VIX Index), is at the lowest point since it was first measured in 2004,” said FTSE Russell.

Year-to-date, IWM's annualized volatility is lower than that of IVV. From 2012 through 2017, IWM's annualized volatility was higher than IVV's each year.

What's Next

IWM's declining volatility isn't only surprising because it's a small-cap fund, but also because the ETF is heavily allocated to sectors that are often volatile at the small-cap level. Technology and healthcare stocks, for example, combine for almost 35 percent of IWM's roster.

“Being less global also gives small caps more exposure to several positives within the US, including tax reform, increasing deregulation and faster economic growth relative to weaker recoveries in Europe and Japan,” said FTSE Russell Managing Director Alec Young. “All these tailwinds are helping drive faster profit growth for small cap companies relative to their blue chip counterparts, helping fuel YTD leadership while tempering relative volatility for this asset class.”

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