For a variety of reasons, retail and institutional investors are turning their attention to small-cap stocks and exchange-traded funds (ETFs) that focus on the small-cap equity sector.
Specifically, favorable relative valuations, historical market trends and recent stock market dynamics have all combined to bring small-cap stocks to the forefront of investors’ minds.
The renewed interest in smaller companies was particularly evident during the last three weeks in July, when small-cap stocks surged and reversed much of their previous lagging performance. Roughly speaking, during that period the Russell 2000, a leading U.S. small-cap benchmark, recovered almost all of its underperformance for the year compared to the large-cap S&P 500.
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Even so, many experts believe that small caps are still trading at a valuation discount. Keeping in mind that precise numbers are difficult to state because they depend on various individual estimates and analyses, by some measures the price-to-earnings (PE) ratio of the small-cap universe is about 30% lower than that of the large-cap universe, and as much as 20% to 25% lower than mid caps.
No one can predict the markets but, historically, this kind of deep relative value — the widest discount since right before the tech bubble of 2000 — suggests a prolonged period of small-cap overperformance could be on the horizon.
If you want to own small caps and take advantage of the possible capitalization rotation that many market watchers are expecting, one of the best ways to do it is with small-cap ETFs. Actively managed ETFs offer professional stock selection. Index ETFs provide a low-cost way for investors to mirror influential market benchmarks. All ETFs offer a higher level of diversification than most investors can achieve on their own.
With that in mind, here’s a list of seven of the very best small-cap ETFs for you to consider today:
| ETF | Expense ratio |
| iShares Russell 2000 ETF (ticker: IWM) | 0.19% |
| Vanguard Small-Cap Value ETF (VBR) | 0.07% |
| SPDR S&P 600 Small Cap Growth ETF (SLYG) | 0.15% |
| Schwab U.S. Small-Cap ETF (SCHA) | 0.04% |
| Direxion Daily Small Cap Bull 3X Shares (TNA) | 1.08% |
| Invesco S&P SmallCap Momentum ETF (XSMO) | 0.39% |
| First Trust Small Cap Value AlphaDEX Fund (FYT) | 0.70% |
iShares Russell 2000 ETF (IWM)
There is no more widely followed small-cap index than the Russell 2000. That benchmark tracks the smallest 2,000 companies by market cap in the larger Russell 3000 Index. It’s a well-known index in the investment industry and is, of course, broadly diversified across 2,000 stocks.
IWM is an ETF in the iShares family of funds that mirrors the Russell 2000. The $64 billion fund has a low expense ratio of just 0.19%, which means investors will experience very little tracking error when measuring performance against the index.
If you’re looking for a core small-cap holding that provides excellent diversification, you need look no further than IWM. This fund has provided a one-year total return of 9.91% based on net asset value (NAV) for the period ending June 30.
Vanguard Small-Cap Value ETF (VBR)
Because Vanguard is a leader in low-cost ETF investing and the CRSP U.S. Small-Cap Value Index is the premier small-cap value index in the industry, you are likely to see VBR on any list of the best small-cap ETFs to own. VBR is a $53 billion ETF that tracks that index very precisely after the low expense ratio of 0.07% is accounted for.
The fund only invests in small-cap stocks that exhibit excellent value characteristics, meaning stocks the portfolio managers believe are significantly undervalued compared to other small caps and the market as a whole.
Additionally, tax-conscious investors will be encouraged to know that this fund has a very low internal turnover. VBR is an ETF that holds stocks for the long run. Plus, the trailing-12-month yield for this ETF stands at a respectable 2%.
SPDR S&P 600 Small Cap Growth ETF (SLYG)
The SPDR ETF SLYG has current assets of about $3.4 billion. This fund mirrors the S&P Small Cap 600 Growth Index. That index is a subset of the larger S&P Small Cap 600 Index, but it only includes growth stocks. Growth stocks are those that have demonstrated superior revenue, earnings and price momentum compared to the broader small-cap sector.
With an expense ratio of just 0.15%, SLYG can be considered a low-cost fund. The low expenses will also ensure close adherence to the performance of the target index.
The assisted living, nursing and rehabilitative care company Ensign Group Inc. (ENSG) is currently the top holding in SLYG, representing about 1.3% of the fund’s assets. There were 348 stocks in the portfolio as of Aug. 13.
Schwab U.S. Small-Cap ETF (SCHA)
SCHA has an impressive $17 billion in assets. This ETF tracks the Dow Jones U.S. Small-Cap Total Stock Market Index. SCHA is a comprehensive ETF designed for investors who want to own as complete a representation of the small-cap stock universe as possible.
SCHA does not specialize in any particular segment, sector or industry. This small-cap fund owns a broad spectrum of industries and individual companies. In other words, SCHA provides investors with excellent diversification.
Another attractive feature of SCHA is the low expense ratio of just 0.04%. The low internal expenses will ensure performance that nearly matches the index. In addition, the fund has a trailing-12-month dividend yield of 1.3%.
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Direxion Daily Small Cap Bull 3X Shares (TNA)
The next small-cap ETF on the list is admittedly not for everyone. TNA is an aggressive, leveraged ETF that promises superior performance when small caps are going up but will greatly underperform when that asset class is going down.
TNA is managed to provide investors with three times the performance of the Russell 2000 Index. The portfolio managers use leverage — that is, buying stocks on margin — to boost performance and, on top of that, they own derivatives like swap contracts that can provide returns roughly triple those of the underlying index.
Direxion does not recommend this fund as a long-term hold. It manages and markets TNA as a short-term trading vehicle that is not suitable for conservative investors or those who do not understand the risks associated with the fund.
Assets in TNA top $3 billion, and investors should be aware that the fund has an above-average expense ratio of 1.08%.
Invesco S&P SmallCap Momentum ETF (XSMO)
The concept of momentum investing is sometimes difficult to define, but investors know it when they see it. In short, momentum investing is a strategy that looks for stocks that are showing a marked uptrend in price appreciation over a specific period — usually three, six, nine or 12 months.
XSMO is based on that concept and is designed to track the S&P Small-Cap 600 Momentum Index. The index comprises stocks in the S&P 600 that are demonstrating pronounced price appreciation.
This $1.2 billion fund currently holds 115 small-cap stocks. All of them score well for momentum factors according to the methodology employed by the designers of the index and compared to its peers.
The expense ratio of 0.39% is reasonable for a fund that reconstitutes semiannually.
First Trust Small Cap Value AlphaDEX Fund (FYT)
FYT is a relatively small ETF — it has $172 million in assets — but because of its unique characteristics, it’s one that small-cap ETF investors should consider. In fact, FYT is one of the most innovative ETFs on the market today.
The fund is based on the Nasdaq AlphaDEX Small-Cap Value Index. The index evaluates short- and mid-term stock prices, general revenue trends, cash flow numbers, and several other data points. The data are used to identify small-cap stocks that can be considered both value and growth stocks.
Nasdaq routinely screens more than 700 stocks per quarter, but well less than 300 will be included in the index and subsequently added to FYT.
The goal of the fund is to match the performance of its underlying index while beating the Nasdaq U.S. 700 Small-Cap Index. The fund has an expense ratio of 0.7%.
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Update 08/14/24: This story was previously published at an earlier date and has been updated with new information.
