Investors cash in as small-cap ETFs falter

BOSTON (MarketWatch) -- Investors are pulling money out of small-cap exchange-traded funds as the group shows signs of weakening, and that could spell trouble for the U.S. market overall.
Small-cap stocks and other riskier sectors that fell hardest in the market meltdown have regained the most ground in the powerful rally that kicked off in March. Yet small-caps recently have yielded leadership to their larger counterparts. This has some market watchers concerned that the rally which has pushed the Dow Jones Industrial Average /quotes/comstock/10w!i:dji/delayed (INDU 10,270, +73.00, +0.72%) up by more than 50% is growing long in the tooth

"It appears that some investors were looking to lock in profits on their broad small-cap holdings following the group's strong outperformance throughout the market's recent rally," said John Gabriel, an ETF analyst at investment researcher Morningstar Inc.

"Many are starting to question the sustainability of the trajectory that higher-beta names have enjoyed over the past several months," he added

For example, a popular ETF tracking small-cap stocks, iShares Russell 2000 Index Fund /quotes/comstock/13*!iwm/quotes/nls/iwm (IWM 58.73, +0.56, +0.96%) , saw more than $1 billion in outflows in October, after bringing in $2.2 billion in new assets the previous three months, Gabriel noted. The ETF has about $12 billion in assets, according to Barclays Global Investors.
For the month ended Nov. 12, iShares Russell 2000 ETF was down 5.3%, trailing the S&P 500 Index /quotes/comstock/21z!i1:in\x (SPX 1,093, +6.24, +0.57%) , which measures U.S. blue-chip stocks, by more than six percentage points.

The fund's three-month gain of 2.1% over the trailing three-month period also lags the S&P 500 by more than six percentage points, according to Morningstar.

"Small-caps are a more volatile area of the equities universe because of the greater macroeconomic risk courted by these smaller companies," the research firm said in its latest report on the ETF.

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