Indexing the Microcaps

I'm actually surprised that we haven't already seen this latest development, but investing in microcap stocks may just have become easier as the Russell Investment Group (the same people behind the Russell 2000 index, among others) has rolled out a new microcap stock index!

The move, which comes as part of Russell's regular reshuffling of the publicly traded companies covered by its indices, should make it possible for small investors to gain access to the market's least capitalized stocks. While there are a number of funds that do include many of these small stocks, many are closed to the public. A recent article by AP business writer Meg Richards explains why this is so (links added):

Microcaps typically have very small trading volumes, so it's difficult to maintain a fund of any size in this space. When new funds appear, their asset levels grow very quickly. They become too large, lose their edge and are typically closed to new investors.

"There's a meaningful number of microcap funds, but unfortunately most of them close because of those liquidity issues," said Russ Kinnel, director of fund research at Chicago-based research firm Morningstar Inc. "One of the challenges investors face in picking a microcap fund is you generally have to choose among very new funds or funds with bad records, because the good ones close."

Russell's new index will cover roughly 3% of the U.S. equity market, for companies that range in market capitalization values from $60 million to $500 million. Meg Richards describes the new Russell index:

It includes companies that are traded on the New York Stock Exchange, the American Stock Exchange and the Nasdaq Stock Market, and excludes any stock on the less-regulated over-the-counter bulletin board or pink-sheet stocks priced under $1. The holdings include companies like 1-800 Contacts Inc., NutriSystem Inc. and Restoration Hardware Inc.

The average market cap for the Russell Microcap Index is $290 million, compared to about $900 million for the Russell 2000.

While investors won't have immediate access to a fund in which they might invest in Russell's new microcap stock index, it is expected that several Exchange Traded Funds (ETFs) will pop up in short order to capture the new index. At present, only Barclays Global Investors, the investment house behind iShares, has licensed Russell's microcap index and has recently filed to register a fund based on the index with the Securities and Exchange Commission.