Mega-cap stocks are everything, right? Wrong. Small-cap exchange-traded funds (ETFs) like the iShares Russell 2000 iShares ETF (IWM) are the way to bust out of what’s working, and into what’s hot, right? Also wrong. I think the remainder of 2026, if it provides any monster upside, might just come from the smallest stocks. I mean, the very smallest stocks.
There are two I’ve followed over time. One is the Micro-Cap iShares ETF (IWC), which owns 1,300 stocks and is part of my ROAR 10 ETF model portfolio, which I’ve discussed here. But I want to give equal time to its top peer, the First Trust Dow Jones Select MicroCap Index Fund ETF (FDM).
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A Closer Look at FDM
FDM offers something entirely different. It provides exposure to the very smallest tier of the U.S. equity market, companies so small that they are often ignored by institutional analysts and passive index funds alike. And, while I do like IWC, FDM has one very distinct feature. Its index managers limit it to 150 stocks.
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The key distinction from IWC is that FDM uses a fundamental filter to screen out stocks that lack liquidity or financial viability. Now, there is some advantage to owning “anything that moves” in microcap land, as IWC does. At times of extreme market FOMO, the meme-like nature of some of those other 1,150 stocks in IWC could provide some added lift.
The other difference is that FDM’s sector weighting is heavily tilted toward financials. That includes many regional banks. That tells me that if and when we have another routine cyclical bank consolidation, FDM is not a must-have ETF, but at least a must-consider.
FDM is thus part of a class of ETFs known as “fundamental index funds.” Those are ETFs that use one or more screens to regularly qualify stocks based on specific criteria. Having enough market cap or liquidity is not enough to secure a slot.
I find the attraction to FDM and the micro-cap equity niche particularly interesting at a time when the market is so enamored with the one-way bet on artificial intelligence (AI) hardware. FDM breaks that mold by diving into a unique subset of the market.
This is the ultimate “ground floor” exposure. When speculative sentiment heats up — as we saw during the March-to-April recovery — FDM often leads the charge. It isn’t just small-cap investing. It is a bet on the entrepreneurs who haven’t yet been commoditized by the major indices.
One Small Problem
Micro-caps are not for the faint of heart. FDM carries significantly more volatility than the broad market. At an expense ratio of 0.60%, you are also paying a premium for the complexity of managing a liquid fund in a relatively illiquid market. Furthermore, these smaller firms are more sensitive to interest rates that remain high for longer, since they do not have the massive cash piles of the Magnificent 7.
You might not recognize too many stocks in FDM’s portfolio. But you will recognize an ETF trading at under 12x trailing earnings as a unicorn in today’s richly valued big-cap environment. Small caps have been relatively ignored. And the smallest of them? Make that a double.
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This ETF is big enough to matter, and you can see from the trailing returns that it had a rough patch during 2022. That’s why the five-year return is higher than the three-year return and about the same as the one-year return. Par for the course with micro-cap stocks.
This daily chart is two things at once, to me. It is overvalued on a PPO basis (the bottom indicator). But that doesn’t matter if the market continues to be as buoyant as it has been recently. That 20-day moving average is not yet rolling over.
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So this is more of what I’d call overvalued, as opposed to vulnerable. We’ll see what comes next. FDM may not be the micro-cap stock ETF in my 10-ETF model. But that doesn’t mean I don’t see the attraction here. If not as an ETF to own, then one to use as a place to scout for very small stocks to trade.
Rob Isbitts created the ROAR Score, based on his 40+ years of technical analysis experience. ROAR helps DIY investors manage risk and create their own portfolios. For Rob’s written research, check out ETFYourself.com.
On the date of publication, Rob Isbitts did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. This article was originally published on Barchart.com
