Last month, I engaged in an enlightening discussion with my fellow market analyst, Jesse Felder on Twitter Spaces; for those of you who were able to listen, I hope it was worth it? One of the topics we explored during the conversation was the conditions in the small cap space. If this is a landscape that interests you and you are looking for opportunities, one option you can consider is the Invesco S&P SmallCap Value with Momentum ETF (NYSEARCA:XSVM). As noted in The Lead-Lag Report, volatility conditions have been a dominant theme in recent weeks, with the VIX reaching rather uncomfortable levels.

Typically, under such conditions these risky assets would likely underperform, but consider that XSVM has proven to be a popular choice over the past month, with its AUM rising in double digits, even as the SPY experienced a contraction of his AUM. . I think this speaks to the quality of the stock selection and relative defensive qualities of the fund, although it remains to be seen whether it can continue to hold up when we have a full fledged risk environment (currently two of my weekly risk signals are up and two are down).

XSVM Portfolio Methodology and Features

XSVM currently offers exposure to approximately 120 stocks and tracks the S&P SmallCap 600 High Momentum Value Index. Rebalancing takes place twice a year and you are now dealing with a portfolio whose last rebalancing closed in the third week of December.

The index goes through several screens to arrive at the final portfolio which consists of small cap stocks with high “value” scores and high “momentum” scores. In the first step, value scores are calculated by evaluating three metrics: a) book value vs. price, b) 12m earnings vs. price, and c) sales vs. 12m price. . A composite value score is calculated and the top 240 performing stocks by that metric move on to the next round of momentum screening. Momentum scores are based on the stock’s relative appreciation against other constituents that have passed the value test and the top 120 stocks make up the final portfolio; the weighting is done on the basis of the value scores.

On a stock-specific basis, the ETF appears to be quite well diversified, with no stock representing a weighting above 2.6%. On top of that, it’s not a particularly heavy ETF, as the top 10 stocks only make up 17% of the total portfolio. I think that’s a useful quality for an ETF, especially since idiosyncratic risks tend to be rather high with small-cap stocks.

In terms of sector-specific dimensions, it’s no surprise to find that XSVM is overweight financials; this sector represents 36% of the total portfolio, more than double the second largest sector, consumer discretionary, which has a weighting of 15%.

When you think about the outlook for banks, you have a pretty unpredictable landscape in front of you. At one end of the equation, it looks like net interest margins could well pick up after a subdued period over the past two years; The Fed has just raised rates by a quarter of a percentage point and has also signaled its intention to continue this theme at the next six meetings this year. However, at the other end of the spectrum, you should also be wondering about the lending growth prospects of financial stocks, as people are already struggling to avoid the spending pressures that come with inflation at its peak. for 40 years. In such an environment, consumer spending could slow and result in less appetite for credit. In these more expensive monetary conditions, you also wonder if the quality of the assets of these banks is likely to deteriorate?

All in all, you have before you a rather mixed picture for the financial sector. As noted in this week’s “Leaders/Laggers” section of the Lead-Lag report, a relative strength ratio measuring financials against the S&P 500 has been ubiquitous in recent weeks, mirroring trends in the Treasury market. These yields had started to stabilize before the February inflation report, but have recently pivoted a lot in just one week.

In summary…

The recent performance of small caps during a period of heightened volatility has been quite a curious phenomenon to watch, as it was at odds with what one would generally expect; this may be because most of these companies have less international exposure than the large caps and we are currently seeing a fairly widespread wave of global volatility.

Perhaps what also helps the small cap case is the theme of valuation contractions which seems to be a fairly obvious red flag for large caps and not so much for the former. You can also get a sense of this with XSVM’s valuations, as it currently only trades at a forward P/E of just 8.7x and a futures price to book value of just 1x. Conversely, something like your blue chip-based SPY is trading at a forward P/E multiple of nearly 20x and a book value price of nearly 3.6x.

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