Small cap stocks have been significantly beating their large cap cousins over the past few months. The Russell 2000 index that measures the performance of the small cap segment of the US equity universe has returned more than 14% in the past six months, versus about 5% return for the large cap US equity indexes. The most important reason for small cap outperformance appears to be the dollar strength.

Even though the dollar has softened after a rather dovish statement from the Fed, it is still up about 7% this year against other major currencies and almost 20% over the past one year. And with the monetary policy divergence, the dollar may continue to appreciate this year though at a slower pace and the may ultimately rise to parity with the Euro.

This surge is really hurting large US companies. S&P 500 companies currently derive about 46% of their earnings from outside of the US and many of them have warned about the impact of stronger dollar on their profits. Strong dollar not only makes their goods less competitive for exports but it also reduces the value of their revenues generated abroad. Smaller companies are more domestically focused and are rather shielded from the adverse impact of the dollar rally.

Further, small cap companies are best positioned to benefit from the growing US economy. Even though the US economy has slowed after very impressive growth in the second and third quarters of 2014, it is still growing faster than the rest of the developed world. Also, the recent slowdown can mostly be attributed to the strong dollar and harsh weather conditions. The economy is expected to pick up further later this year.

A record 325 companies in the S&P Small Cap 600 Index paid dividends last year, up 10% from the prior year. Per S&P Dow Jones, at least 202 of the small-cap payers will increase their pay-out this year.  

In view of the above reasons, investors should take a look at top-ranked small cap growth ETFs. At the same time they should remember that smaller companies carry higher risk than large, stable companies. They are more suitable as small, satellite holdings in the portfolio.

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