November 20, 2009, 5:00 am

Note to Myself: Key Points to Investing During a Bear Market Part2: Remember Small Caps

by: The Financial Blogger    Category: Investment, Market and Risk,Trading
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Yesterday, I had talked about High Yield Bonds ETFs and other products available (like mutual funds) in order to benefit from this asset class. During a bear market, high yield bonds are one of the first asset classes to get pummelled like a 16 year old boy being initiated during football training camp. The second asset class to get its butt kicked is Small Caps.

Small cap companies have the smallest size on the stock market. They usually show very important growth rates during bull markets as it is easier to grow when you are small as opposed to when you are big and established (just think of how hard it is to move a couch potato 😉 ).

On the other hand, small caps are also vulnerable to the economic situation because they depend on consumption growth and need a lot of credit to operate. Some of them don’t even show a profitin the business yet (but they show a lot of potential!).

Then, when the market is getting a cold (not to mention the H1N1 we had last year!), they are the first ones heading to the hospital. While some of them bleed to death, the survivors are stronger and ready to explode during the market recovery.

How to trade small caps?

There is a very similar situation between the high yield bonds and the small caps when it comes down to trading them. You can decide to pick a few stocks and hold them with your prayers that “everything is going to be fine”. They are very hard to predict for any DIY investors as we don’t get much information from financial analysts or financial publications on small caps.

This may be one of the only asset classes I would head more toward a small cap mutual fund than a small cap ETF. Why? Because the knowledge and being on the field can really make a difference when it comes down to selecting the survival of the fittest.

When you choose the small cap ETFs you have to live with all the corpses and the super star at the same time. This could affect your return big time. With the mutual fund, you take the risk that the portfolio manager is wrong but if you select a good one, he can bring in amazing returns.

Another important point would be that you don’t have much choice in small cap ETFs in Canada (I found only one!). Therefore, the mutual fund may be a great pick.

Here are a few funds (I picked the top 5 on morningstar according to 5yr return – second table) and ETFs you can trade in order to get the benefit from the small cap growth:

TICKERSHORT NAMEPRICE (AS OF NOV 2009)
XCS (CDN)ISHARES CDN SMALL CAP$46.90
IJR (US)ISHARES SMALL CAP 600$50.96
VBR (US)VANGUARD SMALL CAP$52.04
GWX (US)SPDR INTL SMALL CAP$25.45

FUND NAME1YR RETURN3 YR RETURN5 YR RETURN
Mavrix Strategic Small Cap11.7%-7.8%11.2%
Manulife ML Elite Canadian Small Cap36.7%-2.1%8.8%
Trans IMS Canadian Small Cap25.4%-4.3%8.7%
Redwood Diversified Equity37.5%0.4%7.8%
Assumption/FDI Canadian Opportunities A41.2%2.7%7.7%

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