The stock market is shifting away from a few dozen tech and mega-cap winners into stocks that have been under-the-radar and left behind. We’re still early in this trend, and buying small-cap ETFs like the Vanguard Small-Cap Index Fund ETF (NYSEARCA:VB), Avantis International Small Cap Value ETF (NYSEARCA:AVDV), and Schwab Fundamental US Small Company ETF (NYSEARCA:FNDA) can set you up for great gains.
The ongoing rotation is money moving from one sector or style to another as conditions change, rather than the whole market moving in lockstep. Small-cap stocks are getting love specifically because earnings growth is broadening beyond the “Magnificent Seven,” and some of these companies are managing to carve out niches and become picks and shovel trades.
Not only that, but interest rates are finally coming down and are expected to come down more. This directly helps small-cap stocks perform better.
Here are three small-cap ETFs to look into before more capital flows their way.
Vanguard Small-Cap Index Fund ETF (VB)
The Vanguard Small-Cap Index Fund ETF is one of the cheapest ETFs you can buy right now, with an expense ratio of just 0.03%. The yield is also not that bad for the gains you are getting, as the 30-day SEC yield is at 1.3%. The low expense ratio is thanks to Vanguard slashing the expense ratios of dozens of its popular funds.
VB follows an indexing approach and tries to replicate its benchmark by holding all, or substantially all, of the stocks in the index in approximately the same weights as the index. In practice, that means very broad diversification.
VB stock is up nearly 7% year-to-date, and that’s better than what most tech stock ETFs will get you. If you look at macros, that’s another feather in VB’s cap since industrials constitute over 21% of its fund, and that’s where the action could be if the U.S. keeps leaning on manufacturing.
Avantis International Small Cap Value ETF (AVDV)
The Avantis International Small Cap Value ETF’s gains have been outstanding, as it is up nearly 61% in the past year. In the past 5 years, the ETF is up just 83%, so most of these gains are coming from the dollar’s weakness, interest rates coming down internationally, plus companies simply catching up to their U.S. counterparts.
Either way, AVDV may rise a lot more if the USD declines. A lot points to that happening, since the current protectionist and export-oriented drives incentivize the government to keep drafting policies to keep the dollar low. And when the dollar is low, international assets will be denominated higher and higher.
I obviously do not expect AVDV to keep handing you 60-70% in gains year after year, but this is one ETF to keep an eye on since it gives you both international diversification and the strongest gains of the three ETFs in this list.
You get a 1.42% dividend yield, with the expense ratio at 0.25%.
Schwab Fundamental US Small Company ETF (FNDA)
FNDA is a fitting ticker, since this ETF does not lean into a company’s market value for its holdings. It instead looks into a company’s fundamentals to determine what “small” really means and then buys those stocks. The result is an ETF that has performed better than the majority of its peers. FNDA is up 9.5% year-to-date and 19% over the past year.
FTSE Russell’s RAFI methodology overview explains that RAFI style fundamental weighting derives weights from reported fundamentals like cash flow, book value, total sales, and dividends, not from price.
That same overview explicitly describes the rebalance effect; it tends to reduce holdings in names whose prices have risen relative to others and increase holdings in companies whose prices have fallen behind their economic measures, which is the built-in “contra trade” behavior. This is why FNDA often behaves like a small blend fund with a value and yield tilt, even though it is still rules-based and broadly diversified.
You can argue, “Is this really a small-cap ETF?” if the underlying portfolio does not factor in size much. I’d agree, since the holdings aren’t strictly companies below a certain market cap cutoff.
At the same time, I do believe this is a plus, not a negative. Certain ETFs simply let go of their small-cap holdings once they start maturing. This is an ETF that does not let go just because the company got too big, and this has helped it reap the gains more.
There are 897 holdings here, with the top one from Compass Inc (NYSE:COMP). These are small-to-medium companies you’ve likely never heard of that are worth having exposure to.
FNDA yields 1.11% and comes with a 0.25% expense ratio.