Small-cap stocks are often the first to sell off ahead of turbulent economic conditions. Indeed, this is the exact scenario that played out in late 2021 when the Federal Reserve first began talking about hiking interest rates. Scores of high-risk, developmental-stage companies saw their share prices plummet in a matter of weeks, followed by a nearly two-year period of stagnation as the Fed kept hiking rates to battle inflation. With the Federal Reserve likely to start cutting rates in 2024, however, small-cap stocks should begin to rally in the coming weeks.
While picking individual stocks can lead to outsize gains, it is also an inherently risky strategy, especially in the small-cap landscape. Instead, many investors lean on exchange-traded funds (ETFs) to capture the upside potential in small-cap stocks during bullish periods. This strategy comes with the added benefit of diversification, which helps to lower a portfolio's exposure to risk. However, there are dozens of small-cap ETFs to choose from. Which one is the best buy?
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Here is a comparison of four of the best-performing small-cap ETFs in recent history.
A comparison of four top performers in the small-cap category
Small-cap stocks can be a potent source of capital appreciation in a portfolio, but not all small-cap ETFs are worth owning. Below is a comparison of four small-cap ETFs based on their performance, yield, expense ratio, turnover ratio, and liquidity.
The first ETF is the Pacer US Small Cap Cash Cows 100 ETF (CALF 0.88%), which tracks the Pacer US Small Cap Cash Cows Index. This index selects small-cap companies that have high free-cash-flow yields, which is a measure of how much cash a company generates relative to its market value. The idea is that companies with strong cash flows can invest in growth, pay dividends, or buy back shares.
The ETF has been the best performer among the four, with a total return of 126% in the past five years, before taxes and assuming reinvestment of dividends. This also beats the performance of the S&P 500 index, which returned 107.4% in the same period. However, CALF also has some drawbacks, such as a high expense ratio of 0.59%, a low dividend yield of 1.19%, and a high turnover ratio of 101%, which means it changes its holdings frequently and may incur more trading costs.
The second ETF is the Schwab U.S. Small-Cap ETF (SCHA 0.73%), which tracks the Dow Jones US Total Stock Market Small Cap Index. This index covers the entire small-cap universe in the U.S., with over 1,740 holdings across various sectors and industries. The ETF has delivered a solid total return of 66.2% in the past five years, although it markedly underperformed the S&P 500 index. However, it has some advantages over the CALF, such as a very low expense ratio of 0.04%, a higher dividend yield of 1.53%, and a lower turnover ratio of 9%. The SCHA also has decent liquidity, with an average daily trading volume of about 1.1 million shares in the past three months.
The third ETF is the SPDR S&P 600 Small Cap Growth ETF (SLYG 0.86%), which follows the S&P SmallCap 600 Growth Index. This index selects small-cap companies that exhibit growth characteristics, such as high earnings growth, sales growth, and return on equity. The SLYG has achieved a total return of 63.5% in the past five years, slightly lagging behind the SCHA, and by extension, the S&P 500 index. It has a moderate expense ratio of 0.15% and a decent dividend yield of 1.35%. However, it has a relatively low liquidity, with an average daily trading volume of less than 200,000 shares in the past three months. The SLYG also has one of the highest turnover ratios on this list at 48%.
The fourth and final ETF is the Vanguard Small Cap Value Index Fund (VBR 0.37%), which follows the CRSP US Small Cap Value Index. This index selects small-cap companies that have low valuations, such as low price-to-earnings ratios, price-to-book ratios, and price-to-cash-flow ratios. The VBR has posted a total return of 74% in the past five years, making it the second-best performer in this comparison. It has a low expense ratio of 0.07% and a high dividend yield of 2.29%. It also has above-average liquidity for the category, with an average daily trading volume of about 544,000 shares in the past three months. Lastly, the VBR has the second-lowest turnover ratio at 13%.
Winner?
On a pure performance basis, the CALF easily takes first prize in this matchup. However, the VBR also scans as an intriguing buy due to its strong performance, low expense ratio, low turnover ratio, and hefty yield.