Small-cap stocks delivered their best monthly performance since November 2020 in April, with the Russell 2000 jumping over 12%. Bank of America strategists foresee continued upside, driven by an anticipated earnings and manufacturing recovery, and recommend specific ETFs like SMLF, JSML, and AVDV for investors seeking targeted exposure. While advising diversification with a 5-10% allocation, experts caution that discerning selection is crucial for the often-inefficient small-cap asset class.
Small-cap investors celebrated significant gains in April, marking their strongest monthly performance since November 2020. The Russell 2000 index soared by more than 12% last month, notably outperforming the large-cap S&P 500, which recorded a 10.4% advance over the same period.
Bank of America strategists, led by equity and quantitative expert Jill Carey Hall, are optimistic about the future of small caps. In a recent report, they stated, "Small caps have outperformed [year to date] and we expect them to continue to lead, driven by an EPS/manufacturing recovery."
Investors looking to capitalize on these potential gains aren't limited to the broader small-cap benchmark. The strategists highlighted opportunities in active management and specific thematic plays within the small-cap sector. Bank of America pointed to several exchange-traded funds (ETFs) that extend beyond the traditional Russell 2000 constituents and focus on industries poised for enhanced returns.
Enhancing Returns with Specific ETFs
- iShares US Small-Cap Equity Factor ETF (SMLF): Hall's team identified SMLF as a compelling option. Over 80% of its holdings are profitable companies, significantly higher than the approximately two-thirds found in the Russell 2000. The fund boasts a five-star and gold rating from Morningstar, an 11% year-to-date gain, and a modest expense ratio of 0.15%. Key stocks in this fund include nVent Electric, an artificial intelligence infrastructure firm up over 65% this year, and Apple supplier Jabil, which has seen a 48% increase.
- Janus Henderson Small Cap Growth Alpha ETF (JSML): For investors targeting companies with rapidly rising earnings estimates, the JSML fund was recommended. Hall's team noted that "Estimate revisions have been an 'all-weather' factor." This ETF exhibits the highest earnings revisions ratio among small-cap ETFs covered by Bank of America's research. JSML has climbed nearly 14% this year, with an expense ratio of 0.30%. Notable holdings include Bloom Energy, a data center power provider that has surged over 230% this year, and data infrastructure stock Credo Technology, up 35%.
- Avantis International Small Cap Value ETF (AVDV): For those seeking to diversify beyond U.S. borders, Bank of America highlighted AVDV. This international small-cap value ETF is up 13% year-to-date and has an expense ratio of 0.36%. The strategists noted its strong performance against U.S. large-growth stocks since the Covid-19 pandemic, coupled with more attractive valuations and lower market correlation.
Diversification and Discerning Investment
While small caps have enjoyed a favorable year, financial planner Gabriel Shahin, founder of Falcon Wealth Planning, advises against an 'all-in' approach. He suggests a 5% to 10% allocation to small caps for portfolio diversification, especially away from large-cap heavy portfolios. However, Shahin stresses the importance of careful selection, urging investors to scrutinize balance sheets and revenue growth when considering smaller companies. He advocates for an active management approach over passive indexing in this sector, emphasizing, "Small cap is an inefficient asset class. Small caps are different and expensive for a reason."
—Reporting contributed by CNBC's Michael Bloom.
