A microcap ETF is a pooled investment vehicle, similar to a mutual fund, that is devoted to stocks of companies with small market capitalization totals. The market price of the ETF, which is short for exchange-traded fund, is dependent upon trading activity rather than the net asset value of the stocks within the fund. One advantage of a microcap ETF is that it allows exposure to a vast number of smaller stocks for a reasonable price. In addition, there is much more flexibility afforded to investors in terms of buying and selling the fund on the market.
Many investors look for opportunities to diversify their portfolios, which can be a pricey task if they attempt to diversify by buying a vast array of securities. Mutual funds allow investors this type of diversification, but they cannot be actively traded like stocks. Exchange-traded funds, which can be traded actively, have become popular because they combine aspects of both mutual funds and stocks. A microcap ETF is an exchange-traded fund devoted to the smaller stocks on the market known as microcaps.
There are different ways to determine what constitutes a microcap stock. Some funds use stocks that fall into a certain range of market capitalization, usually somewhere between $50 million US Dollars (USD) and $300 million USD. The market capitalization of a stock is gauged by taking the current stock price and multiplying it by the shares of the stock owned by investors. On the other hand, some microcap ETF managers call a stock a microcap if its market capitalization ranks at a certain level compared to all other stocks in the market.
Different investment strategies may also be used by fund managers to determine the stocks to be included in a microcap ETF fund. Some funds may simply be devoted to a microcap index, which groups all of the microcap funds and takes an average of their performances. Other fund managers may use more selective strategies to decide which funds to include. This might constitute performing statistical analysis of companies' financial data to determine the small stocks with the highest overall potential.
By using a microcap ETF, an investor essentially has a large portion of the microcap market at his fingertips for a small price. The fact that the fund can be openly traded on the market allows an investor to utilize the fund for different investment techniques, including selling it short, which is a strategy that essentially bets against the good performance of the stocks. In this way, such an ETF provides great versatility in addition to vast exposure to the microcap market.