This article previously appeared in the December issue of ETFR, our subscription-based monthly ETF newsletter. To learn more about ETFR, click here.

A lot of investors have an interest in small-cap stocks; for them, it’s not all about the S&P 500. In small-cap territory, they assume, there’s more growth potential.

That’s even truer of stocks that fall below the usual small-cap cutoff point. One could make the argument about so-called micro caps that there’s nowhere to go but up (or possibly blipping out of existence). After all, as of Sept. 30, the Russell MicroCap Index had an average market capitalization of $268 million, and its largest component was $983 million.

But for the index ETF investor, micro caps are a problematic asset class simply because there are not a lot of vehicles that provide focused exposure—just four ETFs in all.

The largest by far is the iShares Russell Microcap Index Fund (NYSE Arca: IWC), which has assets of roughly $290 million. It was launched in August 2005.

IWC’s underlying index covers 2,000 stocks. It consists of the smallest 1,000 stocks in the well-known Russell 2000 Index and the 1,000 stocks falling below those in market capitalization. However, the fund’s portfolio has been optimized to hold 1,317 stocks. The largest holdings are in Dana Holding Corp., 0.47 percent; Schweitzer-Mauduit Intl. Inc., 0.44 percent; Veeco Instruments Inc., 0.39 percent; First Financial Bancorp, 0.32 percent; and ArvinMeritor Inc., 0.32 percent.

IWC charges 68 basis points.

First-Mover Status Is Key

The PowerShares Zacks Micro Cap Portfolio (NYSE Arca: PZI) is a distant second to IWC in terms of assets, with just $47.8 million. Like IWC, it was launched in August 2005, just a few days later, which goes to show how important the first-mover status really is and perhaps how helpful a well-known brand name can be.

PZI tracks an index from Zacks and holds 400 different companies. That’s fewer than IWC, but still, a broad number in the micro-cap space. Interestingly, PZI has an average market capitalization among its components of $355 million, while IWC has an average of $229 million. So IWC clearly skews a bit smaller in its focus.

PZI’s underlying index is designed to target companies that Zacks believes are likely to outperform the broad micro-cap category. Unfortunately, that doesn’t seem to have worked too well for the past couple of years or so. The fund has under-performed IWC year-to-date for 2009 and in 2008 and 2007 as well, according to Morningstar, though it did outperform IWC in 2006.

Its top holdings are U.S. Energy Corp., 0.43 percent; East West Bancorp Inc., 0.42 percent; China Yuchai International Ltd., 0.42 percent; A. H. Belo Corp., 0.40 percent; and Qiao Xing Mobile Communication Co. Ltd., 0.40 percent. It charges a gross expense ratio of 86 basis points, but has expenses capped at 60 basis points.

First Trust offers the third-largest fund in this category, the First Trust Dow Jones Select MicroCap Index Fund (NYSE Arca: FDM). It has roughly $16.8 million in assets and charges an expense ratio of 60 basis points.

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