Although volatility levels have increased in 2014 thanks to an unprecedented drop in oil prices and wobbling global growth, the U.S. economy continues to climb on the back of growing consumer confidence, an improving employment picture, contained inflation and decent housing data. The economy has grown 4.6% in Q2 and 5% in Q3 after a frozen Q1.

The bourses had nothing to do except follow the global economic backdrop. While the prospering U.S. economy gave these a boost, subdued foreign economies kept the run at check. The S&P 500 index (SPX), though remained above the 2,000 level for most of the second half, and is up roughly 13 percent for the year.

Performance was more muted in the small-cap space with the Russell 2000 index returning about 3.3%. These pint-sized stocks should have performed better as the pack normally generates most of their revenues from the domestic market, which makes them less ruffled in a global slowdown. However, extreme volatility, overvaluation concerns and uncertainty regarding the Fed rate hike seem to have dealt a blow to this small-sized group too.
 
Still, some choices held up in the down year of the small caps. Interestingly, the top performers are spread across a number of sectors, suggesting that there have been winners in various corners of the space and the strength of the sector should be taken into consideration while judging these stocks (read: 3 Outperforming Small Cap ETFs in a Choppy Market).

Below, we have highlighted the top three sector ETFs that have outplayed not only the small cap space, but also the S&P and could be worth a closer look for those with a slightly longer time horizon:

IQ US Real Estate Small Cap ETF (ROOF - ETF report)

Real Estate has been a strong performing sector this year thanks to a plunge in interest rates. Moreover, rising consumption, healing labor markets and favorable affordability favored the Real Estate market.

One ETF that has largely benefited from this trend is ROOF. This fund tracks the IQ US Real Estate Small Cap Index and holds 60 stocks in the basket. It is an unpopular choice with about $82 million in assets and is less liquid with average daily volume of under 25,000 shares. The ETF charges 69 bps in fees per year from investors.

The product is less concentrated across its top 10 securities as no stock accounts for more than 3.59% of the basket. PSCE returned close to 15.9% in the year-to-date time frame, clearly outpacing the Russell 2000 by a wide margin. The fund currently has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook.

S&P SmallCap Information Technology Portfolio (PSCT)
 

The technology sector has been gaining immense popularity of late displaying an earnings beat ratio of 73.0% and revenue beat ratio of 59.5% in Q3. This high-growth sector normally rebounds in a recovering economy (read: Invest in Booming Technologies with These 3 ETFs).

 
As a result, PSCT turned out as an investors’ favorite this year. The fund offers broad exposure to the small-cap tech companies by tracking the S&P SmallCap 600 Information Technology Index. The ETF has AUM of $240.4 million while trades in paltry volumes of 30,000 shares a day. The relatively illiquid nature ensures additional cost for the product beyond the expense ratio of 0.29% (read: 3 Top Ranked ETFs from Hottest Sectors).
 
The product has a large basket of 109 securities, which are widely spread across as each security holds less than 3.95% share of the total basket. The ETF has returned over 14% in the year-to-date time frame. The fund currently has a Zacks ETF Rank #3 with a High risk outlook.

 

S&P Small Cap Utilities Portfolio (PSCU)

The U.S. utility sector has performed remarkably well this year. This defensive sector has benefitted from relentless geopolitical tensions and global growth worries that resulted in elevated levels of risk-off trade sentiment among investors.

 A good way to play this trend was with PSCM, which follows the S&P Small Cap 600 Utilities Index. This fund has added 16.3% year-to-date. The ETF has accumulated $40.0 million in its asset base while volume is paltry at 5,000 shares a day, suggesting additional cost in the form of a wide bid/ask spread beyond the expense ratio of 0.29%.
 
With holdings of 20 stocks, the product is concentrated on its top 10 holdings. Piedmont Natural Gas, Southwest Gas and NorthWestern occupy the top three positions in the basket with more than 25% share. PSCU has a Zacks ETF Rank #3 with a Medium risk outlook.

Bottom Line

While these small cap sector ETFs outdid their large cap counterparts in 2014, these could emerge as a great pick to start the New Year given the Fed’s ‘patient’ bearing on rate issues. So instead of looking to broad products, it might be a wise idea to focus on these well-positioned sectors for solid returns to kick start 2015.