The Top Canadian Small Cap ETF to Look at in January 2023

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For many investors, the lure of investing in small-cap stocks and striking it rich leads them to chase bad opportunities and inevitably lose money.

However, there is no doubt that small cap stocks can be very profitable. We provide them on a monthly basis to StockTrades Premium members.

But, they require extensive research, and errors can be amplified due to their overall volatility. So, for beginners who are just learning How to Buy Stocks in Canada If you are wrong it can lead to some big losses.

So how does the average investor, who doesn’t have the time, knowledge or skills to pick up small-cap stocks, unearth some of these diamonds in the rough?

Well, they can buy a small-cap ETF. Also, if you are looking for a Canadian ETF Holding small-cap stocks, the iShares S&P/TSX Smallcap Index (TSE:XCS) where to look.

What is the best Canadian small cap ETF?

Currently, the iShares S&P/TSX Smallcap Index (TSE:XCS) is the only small-cap ETF option in Canada.

We are very underserved in Canada when it comes to small cap ETFs. Actually, we only have one.

But it’s not because there’s a reluctance to build small-cap ETFs in Canada, it’s just that we don’t have enough small-cap stocks to justify it.

As a result, the iShares S&P/TSX Smallcap Index will be your only option.

How does this small cap ETF perform?

Unfortunately, the past performance of this small cap ETF has been underwhelming, to say the least.

The total returns of this ETF have remained stagnant in the last 13 years. In fact, its historical annualized rate of return since inception is just 1.49%. You should reinvest that income and dividends.

Now, the ETF got off on the wrong foot through no fault of its own. It debuted before the financial crisis and a $10,000 investment in an ETF quickly became worth $4000.

Recovering from the financial crisis, small-cap ETFs have traded relatively sideways over the past decade, providing little long-term capital growth and ultimately giving Canadians an incentive to invest.

As speculation ran high, it resurfaced in the post-pandemic environment. But in 2022, a significant sell-off in small-cap stocks in North America caused this ETF to underperform again.

iShares Small Cap ETF Holdings

The fund’s portfolio includes more than 230 stocks, and its top holding is currently Eldorado Gold (TSE:ELD). Remember this is an index fund. Therefore, the investment strategy ultimately tracks its benchmark, the S&P/TSX SmallCap Index, net of expenses.

Although Eldorado ETFs are at the top, it still only makes up 1.78% of the fund’s allocation. It’s a diversified ETF, with its top 10 holdings accounting for only about 14% of assets.

The top ten stocks in this small cap ETF are diverse. They include subsidiaries Jamison Wellness (JWEL), Sierra Wireless (TSE:SW), Uni-Select (TSE:UNS) and various junior oil and gas and materials plays.

Overall, the ETF has about 30% exposure to the materials sector and almost 20% exposure to oil and gas. So you can definitely expect this ETF to be cyclical.

With this large exposure to gold, silver and copper miners along with oil and gas producers, both of which have been hit by extreme bear markets over the past ten years, it’s no surprise that ETFs have done poorly.

This iShares small-cap ETF comes with an expensive price tag

When it comes to ETFs, fees matter. Paying a hefty fee for an underperforming ETF is a tough pill to swallow.

XCS has a management fee of 0.60%, which means that you will pay $6 for every $1000 invested in this fund.

When all is said and done, this is a break-even investment, considering that it has been able to turn $1000 in capital appreciation over the last 13 years into as little as $1250.

However, ETFs pay a dividend, and more than you might expect from a small-cap ETF. At the time of writing, XCS pays a yield of 2.1%.

This doesn’t make up for its lackluster performance, but it’s definitely an added bonus.

An important point to note is the distribution of funds. It can be generated by different types of income. Return of capital, dividends, capital gain distributions and so on. If you are thinking about buying, it is very important that you understand the impact on your income taxes before doing so.

This Canadian small-cap ETF has exposed the wrong companies

There are plenty of small cap options in Canada. Like I said, we bring them Stock trading premium Members all the time.

However, the XCS has it all wrong.

In my opinion, it’s too cyclical, and Canadians should take advantage of the small cap options we have, and an ETF filled with 50%+ exposure to the commodity and oil and gas sector would not do well.

Overall, I would move forward with it

As an investor who buys individual Canadian small-cap stocks on a regular basis, I know that there are opportunities for high returns in Canada.

However, this small-cap ETF has performed relatively poorly since its inception, and unless gold and oil continue to maintain strength, it will underperform going forward.

I don’t like ETFs’ overexposure to the commodity and oil sectors. It’s one thing to have a small exposure to gold as a hedge against uncertainty, but more than half of this ETF has exposure to commodity or oil stocks, both of which are prone to cyclical activity based on commodity prices.

However, if you decide to avoid this ETF, instead try your hand at investing in individual small-cap stocks or other ETFs that are smaller. Blockchain Technology ETFsThese come with more risk than a blue-chip option.

Always understand how a particular investment fits into your overall risk tolerance and decide whether it is right for you or not.


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