What Is the S&P SmallCap 600?

The stock market benchmarks that people pay the most attention to, like the S&P 500 and the Dow Jones Industrials, focus on large-cap stocks. What many therefore find surprising is that small-cap stocks have dramatically outperformed their larger counterparts over the long haul. The S&P SmallCap 600 Index concentrates on smaller stocks in the market, and its constituents include some of the fastest-growing up-and-coming companies right now. By investing in funds that track the S&P SmallCap 600, you can capture its return over time and tap into the trends that have made investments in small companies successful.

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What the S&P SmallCap 600 index is and how it picks companies

The S&P SmallCap 600 is an index offered by S&P Dow Jones Indices that's designed to measure the small-cap segment of the U.S. equity market. The index has criteria that stocks must meet in order to become components of the income, with the goal of ensuring that any company in the index is financially viable and has sufficient stock liquidity to allow index funds to invest in the stock.

In considering new constituents for the S&P SmallCap 600, S&P Dow Jones Indices looks for market capitalizations of between $450 million and $2.1 billion. Minimum trading of 250,000 shares in each of the six months before the evaluation date is necessary, and the total annual dollar value traded should exceed the company's float-adjusted market cap. Companies must have a U.S. domicile, filing SEC annual reports, listing on a major U.S. exchange, having a U.S.-friendly corporate governance structure, and having the bulk of its fixed assets and revenues come from the U.S. portion of its business. The publicly available shares should make up half or more of the total outstanding. Companies should trade for 12 months or longer after an IPO before being considered, and S&P tries to add companies that keep the index's balance across sectors consistent with the makeup of the entire U.S. stock market.

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S&P Dow Jones Indices also looks at stocks regularly to see if they should be deleted from the S&P SmallCap 600 index. The most common reason is that a company is involved in a merger that makes them ineligible, and delistings as a result of mergers or other corporate actions are often the catalyst for a change in the index. S&P also provides for companies to be removed if they "substantially violate one or more of the addition criteria," with the index manager making it clear that companies typically won't be deleted for this reason unless ongoing conditions warrant a change. Many of the more successful companies in the S&P SmallCap 600 index leave the benchmark when spots open up in larger-cap indexes like the S&P 500 or the S&P MidCap 400 index of mid-sized companies.

How to invest in the S&P SmallCap 600

There are several funds that track the S&P SmallCap 600 index, but as you can see below, only one has caught on with investors to a particularly large extent.

Data source: Fund companies.

Vanguard and SPDR offer token offerings in this space, but neither stands up to the iShares ETF, which dominates its rivals. With expenses of less than half its competitors and a much higher level of assets under management to provide economies of scale and greater trading liquidity, the iShares small-cap ETF has been the clear choice and continues to be the most attractive tracking ETF for the S&P SmallCap 600 Index.

The returns for these ETFs have exceeded the S&P 500's return over the same five-year timeframe, providing another example of the long-term outperformance of small-cap stocks, especially during bull markets. Investors need to understand that with those higher returns comes greater risk, because smaller companies are more prone to fail, and many stagnate without ever growing beyond a limited point. The successful companies do well enough to pull the entire index higher, and that's the hope that small-cap investors have in sticking with the asset class for the future.

Small-cap stocks often go neglected by rank-and-file investors, but their returns are typically superior. By looking at the S&P SmallCap 600 or similar small-cap indexes, you can get simple but effective exposure to the small companies that will drive the future for the U.S. economy.