What is XSMO? (Pros, Cons, and Strategies)

Are you looking for a unique angle in your investment portfolio, particularly in the realm of small-cap stocks? The Invesco S&P SmallCap Momentum ETF (XSMO) might be worth considering. This ETF focuses on capturing the momentum of small-cap stocks in the U.S. market, making it an exciting option for growth-oriented investors. In this post, we will dive into what XSMO is, its key features, and its pros and cons, along with some strategies for investing.

What is XSMO?

XSMO stands for Invesco S&P SmallCap Momentum ETF. This exchange-traded fund seeks to replicate the performance of the S&P SmallCap 600 Momentum Index. The fund focuses on small-cap stocks exhibiting strong momentum, which can be a powerful factor in driving stock prices higher.

Momentum investing relies on the idea that stocks that have performed well in the past will continue to perform well in the near future. By targeting small-cap stocks that show strong momentum, XSMO aims to offer higher growth potential while maintaining diversification within the small-cap sector.

Key Features of XSMO

• Focus on Momentum: XSMO selects stocks based on their past performance in terms of price momentum, targeting those with the highest momentum scores.
• Small-Cap Exposure: The fund offers exposure to small-cap stocks, which are typically companies with market capitalizations of $300 million to $2 billion.
• S&P SmallCap 600 Index: The selection pool is drawn from the S&P SmallCap 600 Index, ensuring a degree of quality and liquidity among the small-cap stocks.

XSMO Composition

The ETF's holdings are concentrated in small-cap companies across a variety of sectors, with a significant weighting toward industrials, consumer discretionary, and healthcare sectors. Stocks in this ETF are selected based on their momentum scores and are regularly rebalanced to capture ongoing momentum trends.

Pros of XSMO

High Growth Potential

One of the standout features of XSMO is its potential for high growth. Small-cap stocks generally have higher growth potential compared to large-cap stocks due to their size and the possibility of scaling up significantly. By focusing on momentum, XSMO aims to capture the best-performing small-cap stocks, which could lead to substantial appreciation.

Diversification within Small-Caps

XSMO offers diversified exposure within the small-cap sector by investing across various industries. This aspect can help mitigate the risk associated with investing in smaller, potentially more volatile companies. Diversification is a crucial factor in balancing the inherent risks associated with small-cap investing.

Tactical Rebalancing

The ETF is rebalanced regularly to ensure it continues to capture the strongest momentum stocks. This tactical rebalancing helps in maintaining the fund's focus on high-performing stocks, ensuring that the portfolio reflects current market trends.

Potential for Outperformance

Historically, momentum investing has been a successful strategy, often outperforming broader market indices. By leveraging this strategy within the small-cap segment, XSMO has the potential to deliver superior returns compared to traditional small-cap indices.

Cons of XSMO

Higher Volatility

Small-cap stocks are inherently more volatile than large-cap stocks, and adding the element of momentum can increase this volatility further. Investors need to be comfortable with this higher level of risk and the possibility of significant drawdowns.

Sector Concentration

While XSMO diversifies across industries, it can still exhibit sector concentration risk, particularly within areas like industrials or consumer discretionary. If a specific sector experiences a downturn, the ETF's performance could be heavily impacted.

Cost Considerations

XSMO has an expense ratio of 0.39%, which is higher compared to some broad-market ETFs. This expense ratio reflects the fund's active rebalancing and focus on momentum, but it is something investors should consider when evaluating their overall investment costs.

Unsuitable for Dividend Investors

XSMO is primarily focused on capital appreciation rather than dividend income. Investors seeking regular income through dividends might find other ETFs more suitable for their portfolio needs.

XSMO Investment Strategies

Given its focus on momentum and small caps, XSMO might appeal more to investors who are looking for growth and can tolerate higher risk. Below are a few potential strategies for investing in XSMO.

Long-term Growth Strategy

Investors with a long-term horizon might find XSMO attractive due to its high growth potential. While the ETF can be volatile, holding it over an extended period can potentially smooth out short-term fluctuations and capitalize on the growth trends of high-momentum small-cap stocks. A regular investment strategy, such as dollar-cost averaging, could help manage volatility.

Tactical Allocation

XSMO can be used as a tactical allocation in a diversified portfolio. For instance, if an investor believes that small-cap stocks will outperform over the next few years, they could allocate a portion of their portfolio to XSMO. This approach allows investors to tactically take advantage of specific market conditions while maintaining a broader diversified portfolio.

Momentum Overlay

For investors already holding a diversified ETF portfolio, XSMO can add a momentum overlay to enhance returns. By investing a smaller portion in XSMO, investors can potentially boost the growth of their overall portfolio without significantly increasing their risk profile.

Rebalance Regularly

Given the volatility of small-cap stocks and the momentum focus of XSMO, regular rebalancing of one's portfolio is crucial. This strategy ensures that the portfolio remains aligned with the investor's risk tolerance and investment goals. It can help lock in gains from high-performing stocks and mitigate risks from underperforming ones.

Conclusion

Invesco S&P SmallCap Momentum ETF (XSMO) offers an exciting opportunity to capture the growth potential of high-momentum small-cap stocks. With its focus on momentum and regular rebalancing, XSMO aims to provide superior returns, albeit with higher risk and volatility. Investors interested in high growth and willing to tolerate the inherent risks of small-cap investing might find XSMO to be a valuable addition to their portfolios. As always, it's essential to align any investment with your overall financial goals, risk tolerance, and investment horizon.