1 Overlooked ETF to Invest in Small-Cap Tech Stocks

Small-cap stocks have surged back into the spotlight, driven by shifting rate-cut expectations. The Russell 2000 Index (RUT), a benchmark for small-caps, is now up more than 10% on a YTD basis, with nearly all of that gain collected over just the past month. 

The resurgence in small-caps has been fueled by rising expectations for an interest-rate cut at the Fed's September meeting, which should be particularly beneficial to smaller companies that depend on financing to fuel their growth. At the same time, investors are seeking alternatives to the mega-cap tech giants that have led this bull market higher - and whose high valuations now bring to mind memories of the dotcom bubble for some wary analysts.

So, while they looked like "dead money" earlier this year, small-cap stocks are now Wall Street's new favorites. And as investors rotate out of some much-loved mega-cap tech stocks, one underperforming ETF is positioning itself as a potential goldmine for investors looking to capitalize on the small-cap tech boom. 

This overlooked exchange-traded fund (ETF), the Invesco S&P SmallCap Information Technology ETF (PSCT), looks like a solid momentum play after underperforming the Nasdaq-100 Index ($IUXX) by an unusually wide margin, according to DataTrek. With its focused exposure to the burgeoning small-cap tech sector, PSCT offers a unique opportunity to tap into the potential of tomorrow's tech leaders. 

Overview of PSCT

The Invesco S&P SmallCap Information Technology ETF (PSCT) is a focused bet on small-cap tech companies that could be tomorrow's big players. This ETF tracks the S&P SmallCap 600 Capped Information Technology Index, and has been around since 2010. PSCT currently has assets under management (AUM) of $342 million. 

The fund invests at least 90% of its total assets in the securities that comprise its index, including companies involved in IT products and services like computer hardware, software, Internet services, electronics, semiconductors, and communication technologies.

The fund's average trading volume of about 37,000 shares indicates relatively low liquidity compared to larger ETFs. This lower volume can potentially lead to wider bid-ask spreads, so it's best to set your entry orders carefully here, and practice some patience in waiting for your price. That said, active traders may want to skip PSCT entirely, due to the risk of slippage on quicker entries and exits.

In terms of valuation, PSCT leans heavily into the small-cap growth category, with 44.67% of its holdings meeting this classification.

PSCT's top holdings give a good sense of where it's placing its bets. Currently, the largest positions include Fabrinet (FN), at 5.46%; SPS Commerce (SPSC), at 4.72%; Marathon Digital Holdings (MARA), at 4.03%; Badger Meter (BMI), at 3.65%; and Insight Enterprises (NSIT), at 3.70%. These companies offer a mix of hardware, software, and digital services, providing diversified exposure within the small-cap tech space.

On a YTD basis, PSCT is up just 2.7%, compared to a 17.6% return for the Nasdaq-100. From its April lows, however, the fund has rallied 17%.

When it comes to dividends, PSCT takes a growth-oriented approach, offering a modest 0.04% annual yield. Its most recent dividend of $0.001 was paid out on June 24, 2024. The ETF has an expense ratio of 0.29%, which is relatively low for a specialized fund, making it a cost-effective option for investors looking to gain exposure to small-cap tech stocks.

The Appeal of Small-Cap Tech Stocks Amid Sector Rotation

The small-cap tech sector is experiencing a significant rotation, capturing the attention of investors eager to capitalize on its potential. For months, small-cap stocks were considered "dead money" as investors poured capital into massive tech stocks. However, the narrative began to change earlier this month, when June inflation data came in lower than expected. This tame inflation has boosted expectations that the Federal Reserve will cut rates as soon as September, alleviating some of the pressures from elevated borrowing costs that have been a headwind for small-cap stocks.

The rotation out of large-cap tech stocks has also played a significant role in this shift. The tech-heavy Nasdaq-100 is down 3% over the last five days, including its biggest one-day drop of the year on July 17. During the same time frame, the RUT is off just 1%, showing impressive relative strength.

Historically, sharp rallies in small-cap stocks have boded well for their near-term performance. The Russell 2000's recent streak of five consecutive days with gains exceeding 1% has only happened four times before, and each time, the index posted an average increase of 5.9% over the following month, per Bespoke Investment Group data. This historical trend suggests that the current momentum could continue.

That thesis is echoed by Tom Lee of Fundstrat, who recently outlined a five-point argument detailing why small-caps are the most compelling investment case right now. Lee anticipates up to 40% more upside in the benchmark RUT, with the upside move lasting up to 10 weeks.

What's the Bottom Line on This Small-Cap Tech Trade?

The Invesco S&P SmallCap Information Technology ETF (PSCT) offers a unique opportunity to tap into a basket of small-cap tech stocks with one investment. Despite recent volatility, PSCT's diverse holdings, competitive expense ratio, and promising growth potential make it a compelling option for investors. 

With experts forecasting significant upside and a favorable market environment for the small-cap tech space, PSCT is one way to invest in the next wave of tech innovation.