2024-05-02 11:02:46 ET
American stocks have done well in the past decades, helped by large inflows by retail and institutional investors and strong earnings growth. The biggest stock indices like the Dow Jones, S&P 500, and Nasdaq 100 have more than doubled in the past decade.
IWM ETF has underperformed peers
The small-cap Russell 2000 index has historically underperformed the other blue-chip funds. A closer look shows that the iShares Russell 2000 ETF (IWM) has risen by 33% in the past five years while the Invesco QQQ (QQQ), SPDR S&P 500 (SPY), and SPDR Dow Jones (DIA) funds have risen by 130%, 85%, and 60%.
The same trend has happened this year, with the IWM falling by 2.20% while the other indices have risen by over 1%. Therefore, a common question is whether it is ideal to invest in the small-cap index.
IWM ETF vs SPY, QQQ vs DIA
Investing in the Russell 2000 index is riskier compared to the other blue-chip indices for several reasons. First, is the fact that most of its constituent companies are being hurt by higher interest rates in the US.
Higher rates hurt smaller companies more than giants like Apple, Microsoft, and Meta Platforms because they usually have lower cash reserves in their balance sheets. For example, Meta Platforms made over $1.6 billion in interest income in 2023. Microsoft made almost $3 billion because of the huge sums it has on its balance sheet.
Many small-cap companies, on the other hand, spent more money on interest. Super Micro Computer, the biggest company in the Russell 2000 index, spent $10.5 million in interest in 2023. Comfort Systems, a big player in the fund, spent a similar amount.
Less exposed to the technology sector
Second, the Russell 2000 index has a smaller exposure to the fast-growing technology sector compared to the other indices. Most of its companies are in the industrial, financial, and healthcare industries.
Historically, the tech sector has been the best-performing sector because it has access to forward-looking sectors like cloud computing, artificial intelligence, quantum computing, and machine learning.
As a result, its earnings growth has been weaker recently. Data by Refinitiv shows that the blended earnings growth estimate for the index is -11.5%, lower than the S&P 500’s 3.5%.
Third, despite its underperformance, the Russell 2000 index is quite overvalued. Data by Barrons shows that the fund has a PE ratio of 26.4, higher than the S&P 500 has a multiple of 22.60. It is a bit cheaper than the Nasdaq 100 index which has a multiple of 29.6.
Finally, the Russell 2000 index is made up of companies that are highly volatile like Bitcoin miners and biotech. Also, most companies in the fund have little exposure internationally, meaning that their performance tends to be in line with that of the US GDP.
The iShares Russell 2000 ETF is a good fund for people seeking exposure to small-cap companies. It is also a good fund for diversification purposes. However, based on its historic performance, it has a good track record of underperforming the bigger indices like the S&P 500 and Nasdaq 100.
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