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Microcaps worth a look

Meg Richards Associated Press

NEW YORK – The biggest stocks get a lot of fanfare, but Wall Street’s tiniest companies have yielded even greater rewards in recent years. Microcap stocks perform very differently from larger issues, but investing in corporate America’s incubator can be tricky for individuals.

There are plenty of ways to invest in large-caps, including a multitude of mutual and exchange traded funds that track the Standard & Poor’s 500. But there simply aren’t many fund options available for investing in the market’s smallest stocks.

This is mostly due to liquidity. Microcaps typically have very small trading volumes, so it’s difficult to maintain a fund of any size in this space. When new funds appear, their asset levels grow very quickly. They become too large, lose their edge and are typically closed to new investors.

“There’s a meaningful number of microcap funds, but unfortunately most of them close because of those liquidity issues,” said Russ Kinnel, director of fund research at Chicago-based research firm Morningstar Inc. “One of the challenges investors face in picking a microcap fund is you generally have to choose among very new funds or funds with bad records, because the good ones close.”

Professional money managers are usually eager to invest in microcaps because they add diversity to equity portfolios. For this reason, the Russell Investment Group is adding a new microcap index when it reconstitutes its family of indexes June 24, to better evaluate the performance of this special group of stocks.

“This segment of the market offers a great way for small investors to get access to these companies,” said Lori Richards, senior product manager at Russell Indexes. “A lot of these guys will be the small- and mid-caps of the future, and you get in on them when they’re babies this way.”

The company already publishes the widely watched Russell 2000 index, a benchmark for small companies. The biggest company in the Russell 2000 has a market cap of $1.8 billion, and the smallest is worth just $176 million. But it’s dominated by stocks in the upper end of that range; companies with market caps ranging between $1.7 billion and $600 million account for about 75 percent of its value.

In contrast, microcap managers typically focus on stocks with market caps ranging from about $500 million to about $60 million. This is a much larger group of companies than you might guess, accounting for literally thousands of names – most of the publicly traded companies in the United States. The new Microcap Index, which aims to track the performance of the 2,000 smallest companies in the U.S. market, has some overlap with the Russell 2000. It includes the bottom 25 percent of stocks in the small-cap index, about 1,000 names, plus another 1,000 even tinier issues.

The new index is designed to replicate the universe of stocks where microcap managers are shopping – about 3 percent of the U.S. equity market. It includes companies that are traded on the New York Stock Exchange, the American Stock Exchange and the Nasdaq Stock Market, and excludes any stock on the less-regulated over-the-counter bulletin board or pink-sheet stocks priced under $1.

The average market cap for the Russell Microcap Index is $290 million, compared to about $900 million for the Russell 2000.

There is no ETF based on Russell’s Microcap Index, but it’s highly likely there will be, Richards said. If nothing else, the new benchmark, which can be seen on Russell’s Web site, provides a fresh way for investors to evaluate the returns of microcap fund managers.

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