iShares S&P SmallCap 600 Index (ETF) (IJR)

iShares SmallCap Index fund (IJR) tracks the Standard and Poors SmallCap 600 Index, which include companies that have market capitalization between $300 million and $1 billion. With prime exposure into financial, IT and industrial sectors, the index restricts itself to high-quality companies with four consecutive quarters of positive earnings, thereby giving a broad diversification to its investors.

For the past two years, the Federal Reserve’s key job has been to raise interest rates, ensuring that inflation remains under control. Unfortunately, at this stage of the cycle, inflation and growth indicators frequently send mixed signals, with high interest rates slowing down the economy. With weakening domestic demand and a tough competition from bigger companies, these small-cap companies will have to perform outstandingly to get away with the slowing economic conditions.

Small-cap funds are heavily exposed to the consumer discretionary sector, at about 30% of assets, compared with about 10% for the Standard and Poors 500, making them more vulnerable to any consumer slowdown. Endorsing the same, its one-year return for 2006 is just 14.94% as against 15.12% reported by benchmark index. As the economic conditions hung in indecisiveness, year 2007 can be a replica of sagging profitability that companies suffered during the economic recession of 2001-02.

IJR also doesn't stand up well when expenses are considered, with its 0.20% expense ratio being not the cheapest way to put on small-cap exposure. Vanguard's ETF VTMSX charges a lower expense ratio of 0.14%, which should certainly stimulate the investors’ sentiments. Though, the fund provides a broad small-cap exposure, other ETFs have lower expense ratios and more tax-efficient benchmarks that dulls this fund's competitive edge.