Why These "Micro-Cap" ETFs are Really Just Small Caps

I want to get on my high horse, which is something I tend to like to do on this show, but none of these are micro cap funds. I want to start there. I actually dug into this because I used to cover small caps when I worked at Fidelity SAI. Then when I worked at Aerial, we had a true micro cap fund in the Aerial Discovery Fund.

Micro cap is inherently difficult to trade. It actually has very limited liquidity, and all of these funds use liquidity screens. But on top of that, if you look at the bottom 20% of all US market cap stocks, and FDM says that they look to invest in the bottom 20% of stocks that trade on the NYSE or the NASDAQ, if you just look at that, the market cap of those names, whether they trade on an index or not, is between 30 million and 300 million.

They don't actually trade on exchanges. They're penny stocks for all intents and purposes. Micro caps inherently have attributes to them that make them unusual and a very good diversifier. They're almost like the only way you can get kind of venture capital/private equity exposure in public markets because they do trade in that sense. These are all small cap funds.

With that in mind, I agree with Mike in that the FDM, the First Trust product, seems to have the clearest screens and also generally speaking has an average market cap of the securities in the portfolio that I can get behind as being like the smallest of the small cap at 1 billion. IWC's average market cap is 750 million, but there's not a big jump between 750 and 1 billion, and the jump is really a quality and a liquidity differential. When you're going to be more concentrated in the space, you got to have liquidity as a key screen.

So for me, I agree with Mike, the standout for me is FDM. I do think it has a better methodology, but let's not pretend it's active because it's not, it's just a better passive and the way they're going about and approaching the space. So it's FDM for me with a caveat that none of these are micro cap funds.