Investors Jittery About Future Of Small Caps

The move shows nervousness about the asset class' future, as short interest reflects how much investors are betting an investment will drop in value.

Unlike mutual funds, ETFs can be sold short easily because they trade on exchanges as stocks do and are valued intraday. Exchanges release short interest data at midmonth.

Short interest shrank the most in the financial sector, with those ETFs showing a 55.9% decrease in the assets held short.

Still Some Pessimism

The sector still shows a high ratio of short-to-long positions. Assets in financial sector ETFs were $5.64 billion with $4.75 billion held short, or 87.2%.

But the decrease in short interest indicates that investors have gained confidence in the financial sector, which was battered during the July-August market correction as worries about the subprime mortgage meltdown raged.

Financials ETFs returned 2.0% in September, but were still down 6.8% year to date.

Short interest also came down in the energy sector.

Across the ETF market, short interest was 19.5% of total assets, a 3.3% decrease. Most types of ETFs showed a drop in short interest as a percentage of assets.

Anthony Rochte, senior managing director at State Street, says short interest would be expected in the ETFs with bigger pools of assets, and small cap is one of those. Small caps also have outperformed big caps in the bull market that started in March 2003. "Perhaps investors felt (that) small (caps) had had a pretty good run," he said.

Short-covering in financials may have been in response to the Fed's 0.5 percentage point cut in the federal funds rate, he adds.

Favored Sectors

For September, assets went up the most in commodity and international ETFs, which increased 21% and 13.5% respectively. Internationals were bigger gainers in absolute dollars, at $17.9 billion, against $3.5 billion for commodities.

For purely U.S. sectors, basic materials ETFs' assets gained 22.3% in September while financials' assets fell 4.3%.

Among State Street's own, $5.69 billion flowed into SPDR S&P 500 (AMEX: - ) in September and $1.02 billion went into StreetTracks Gold Trust (NYSE: - ).

Those two ETFs also showed the biggest year-to-date inflow. SPDR S&P 500 picked up $9.55 billion and StreetTracks Gold took in $2.38 billion.

Rochte says gold showed one of its best quarters since it was rolled out. "Investors clearly were interested in gold as a hedge," he said.

The biggest outflow was from Financial Select Sector SPDR (AMEX: - ), which lost $752 million.