ETF Talk: Small Caps Ride High

Small-cap exchange-traded funds (ETFs) have been on a decided uptrend so far in 2012. Despite the market’s pullback today, ProShares Ultra SmallCap600 ETF (SAA) is up 20.2% so far this year through the close of trading yesterday. The following chart shows the fund’s recovery from the plunge it took in the second half of 2011.

ProShares Ultra SmallCap600 seeks daily investment results, before fees and expenses, that correspond to twice the daily performance of the S&P SmallCap 600 Index. As a result, the fund is designed to give you double the gains that the index would achieve. However, the fund also would give you twice the downside of any pullback in the index. You need to be aware of the heightened risk that a leveraged fund such as this one carries before you consider investing in it.

On the plus side, I want to bring your attention to the fund’s diversification. At year-end 2011, the index that the fund is intended to mirror had the following five sectors as its top holdings: financial, 19.28%; consumer, non-cyclical, 19.10%; industrial, 18.25%; consumer, cyclical, 15.75%; technology, 10.96%. As a result, SSA is not overly dependent on the success of any one sector.

The top five holdings of SAA, as of the close of trading on April 3, were: Kilroy Realty Corp Com, 0.63%; Salix Pharmaceuticals Ltd., 0.61%; Mid-America Apartment, 0.55%; Cubist Pharmaceuticals, 0.54%; and Tanger Factory Outlet, 0.54%. Salix and Cubist give the fund two pharmaceutical companies in its top five holdings. Cubist also was among the top holdings of iShares S&P SmallCap 600 Index ETF (IJR), the fund that I featured in last week’s ETF Talk. If pharmaceutical stocks continue to do well and financial stocks rebound, SSA has the potential to soar.

However, today’s market pullback shows that nothing is guaranteed. SSA dropped and its leverage caused it to fall twice as much as its related index. Leveraged funds can boost your profit or worsen your losses, so only invest in them if you understand the potential rewards and risks.

If you want my advice about buying and selling specific ETFs, including appropriate stop losses, please consider subscribing to my ETF Trader service. As always, I am happy to answer your questions about ETFs, so do not hesitate to email me by clicking here. You just may see your question answered in a future ETF Talk.