After the 2008 market downturn, many investors struggle with uncertainty about how to allocate their assets and position their portfolios for a potential recovery. While small cap stocks can be more volatile and harder hit in down markets, they can also be potentially more attractive than their larger cap counterparts following a recession. WisdomTree’s Inc. (NASDAQ:WETF) SmallCap Earnings Fund (EES), which hit its 5 year anniversary at the end of February, has outperformed the Russell 2000 Index as well as the vast majority of small cap managers within its peer group as defined by Morningstar, Inc. (NASDAQ:MORN). Given its track record, we believe the WisdomTree Investments, Inc. (NASDAQ:WETF) WisdomTree SmallCap Earnings Fund (NYSE:EES) is a differentiated and compelling strategy for small cap exposure.
As discussed in WisdomTree Research – The Case for Small Cap Earnings, over the last 15 years, the S&P SmallCap 600 Index has produced a higher return with a lower standard deviation than the Russell 2000 Index. WisdomTree believes this is extremely significant because a large part of the S&P SmallCap 600 Index’s outperformance can be explained by its stipulation to only include profitable companies. This screen – weighting by earnings – helps eliminate some of the riskier, more speculative small cap growth companies that have yet to earn a profit. WisdomTree’s SmallCap Earnings Fund (EES) builds upon this concept: EES weights securities by their contribution to the earnings stream, which we define as the sum of aggregate earnings generated by all companies in the index.
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Here’s how the WisdomTree SmallCap Earnings Fund (EES) works:
Valuation – The earnings weighted approach tilts weight toward stocks with lower price-to-earnings (P/E) ratios than would be seen with a market cap-weighting scheme of the same stocks. The result? Companies generating the greatest core earnings receive the highest weights within the index.
Maintaining Pure Small Cap Exposure – Investors have learned to be wary of style and size drift. Because we first select from a universe of profitable small cap before applying our fundamental weighting methodology, market cap exposure is maintained with larger market cap companies being moved to the mid- or large-cap earnings Index variants.
Fundamental Metrics – Companies unable to demonstrate profitability for the prior four consecutive quarters are removed at the time of our annual rebalance, thus removed from the selection universe and replaced by profitable companies.