Monday, February 14, 2011

Microcap ETFs -- Bad Imitation of the Real Thing

Microcap Investor Functional Inspiration: Money and Innovation in the Microsphere

By Josh Levine
www.levinesmicrocapinvestor.com

February 14, 2011-New York, NY –

When it comes to microcap investing I'm a purist. I build our MicroCap Investor portfolio carefully
one stock at a time with the aim of generating tremendous profits from a relatively small selection
companies of developing high-value technologies in biotech, cleantech, and various emerging
technologies.

That's my preference, and while there are certainly other ways to participate in microcaps, there
is at least one strategy that makes absolutely no sense at all: Microcap ETFs. Money is a terrible
thing to waste, and these investments will definitely do just that.

The selling point for microcap ETFs is that they offer investors who don't have the time or
experience a ready means of participating in microcap investing. But as a Morningstar article
[LINK: http://news.morningstar.com/articlenet/article.aspx?id=369511] recently highlights, this
approach is a lousy strategy.

Most of the problems have to do with the nature of these little beasts, which are much less liquid
than their larger brethren. The best ETFs hold equities that trade in efficient, deep, and liquid
markets -- everything that microcaps can't provide.

I'm a fan of using ETFs for sector investing or quick-and-easy hedges on the short side, but for
microcaps Morningstar warns that these ETFs are “some of the worst in the world.” They explain
that “microcap ETFs fall prey to nearly every weakness in the ETF structure, which devastates
their returns.”

Let's be real. Using ETFs to invest in microcaps gives investors the sensation of participating in
this market segment. In reality, though, investors are saddled with a large basket of small stocks
that underperform even relative to the indexes they're tracking. As Morningstar points out, "after
controlling for the ETFs' risk exposures, such as size, value and momentum, they trailed their true
benchmarks by about 6% annually."

What's even more disturbing is that microcap ETFs have never been more popular. On the back
of great performance since September, investors have poured in over $300 million into the four
microcap ETFs (the most ever!), according to Morningstar.

By now you're probably thinking that microcap mutual funds must offer a much better alternative
to ETFs. Not so. Exploitive costs aside, most microcap funds invest in 50 to 100, and sometimes
more companies, and that dilutes the best strategic advantages (e.g. focus and leverage) of
investing in small stocks.

The truth is that microcaps are not well-suited for passive investors. For any serious investor who
wants to have 5% to 20% exposure to microcaps in his or her portfolio, you've got to be prepared
to do your homework because there are no ready-made shortcuts. To take advantage of the
often staggering inefficiencies and opportunities in the microsphere, you have to do the research,
monitor your investments, and actively manage this portion of your portfolio.

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MicroCap Investor delves deep into the world of small stocks to identify big winners. Levine
targets innovative companies on the path of the new and revolutionary, developing technologies
that disrupt entrenched markets to create tremendous value.

About Josh Levine and Levine's MicroCap Investor www.levinesmicrocapinvestor.com

Josh Levine has 25 years of senior-level experience in analyzing technology trends and investing
in top-performing micro- and small-cap stocks. He excels at assessing management teams and
evaluating new innovations and their impact on corporate valuations.

In 2002 he joined independent investment-research boutique ChangeWave Research, where he
was editor of ChangeWave MicroCap Investor since 2004, becoming Levine's MicroCap Investor
in 2010. He has been editor of the flagship ChangeWave Investing since 2007.

Levine is also senior analyst for ChangeWave Research. Through its survey network comprised
of 25,000 members, ChangeWave tracks the rate of change in corporate and consumer demand
trends and provides the results through an institutional research subscription service. Its
macroeconomic research is among the best on Wall Street.
More on Levine’s bio: http://www.levinesmicrocapinvestor.com/aboutus/

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