New Thinking In A Small-Cap ETF

One drawback to small-cap stocks is that they historically sport valuations above those found on large-caps. A new exchange traded fund looks to reduce the high valuation conundrum associated with smaller stocks.

The Legg Mason Small-Cap Quality Value ETF SQLV debuted last week. SQLV, the latest smart beta ETF from Maryland-based Legg Mason Inc. LM, uses proprietary research from Royce & Associates, one of the most well-known managers in the world of active small-cap funds.

"The Small-Cap Quality Value ETF tries to reflect the performance of the Royce Small-Cap Equity Value Index, which is comprised of small-cap companies with lower than average valuation, higher than average profitability and higher than average debt coverage," reports ETF Trends.

Another Multi-Factor ETF

The Legg Mason Small-Cap Quality Value is the latest in a long line of multi-factor ETFs that have been coming to market this year. SQLV's methodology focuses on profitable (quality factor) small-caps selling at attractive valuations (value factor), according to Legg Mason.

The Royce Small-Cap Quality Value Index aims to top the Russell 2000 Index, one of the most widely followed U.S. small-cap benchmarks.

"Fundamental weighting aims to add value by relying on more efficient estimations of the companies’ true economic value than those provided by market capitalization. Targets lower exposure to overvalued companies, while still maintaining broad diversification,” according to Legg Mason.

Big Potential

The Royce Small-Cap Value Fund, an active fund that uses a methodology similar to that seen with SQLV, has on a monthly basis “outperformed the Russell 2000 in 63% of all 10-Year periods; 58% of all 5-Year periods; and 55% of all 1-Year periods,” according to Royce.

SQLV is the 11th ETF in the Legg Mason stable and fourth ETF launched by the firm this year. The new ETF charges 0.6 percent per year, or $60 on a $10,000 investment.

In SQLV “each security’s momentum score, which is based on the price performance over the most recent 30 days, is used to determine the timing of the addition or deletion of the security. Position weights are then calculated using a composite score based on company fundamentals that include book value, revenue, free cash flow, and dividends paid,” according to ETF Trends.

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