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ETF Specialist

Be Very Careful With Micro-Cap ETFs

For micro-cap exposure, we would recommend mutual funds over ETFs.

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Micro-cap exchange-traded funds have never been more popular. On the back of great performance since September, investors have poured in over $300 million into the four micro-cap exchange-traded funds, the most ever (see the graph and table below). In doing so, they are buying some of the worst ETFs on the market today.

I like ETFs. I keep most of my assets in them. However, they're not suitable for every asset class. Micro-cap ETFs fall prey to nearly every weakness in the ETF structure, which devastates their returns. Since inception, the average micro-cap ETF has a monthly alpha of negative 0.50%, or negative 6.2% annualized. In laymen's terms, after controlling for the ETFs' risk exposures, such as size, value and momentum, they trailed their true benchmarks by about 6% annually.

Samuel Lee does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.