The U.S. stock market has been dominated by large-cap growth stocks ever since the Federal Reserve began to increase interest rates in March 2022. This trend can be explained by two factors.
First, established companies with a strong competitive advantage usually do not need to borrow money to fund their growth, so they are less sensitive to the Fed's interest rate actions. Second, the emerging themes of artificial intelligence (AI) and weight-loss drug sales have boosted the performance of several giant companies like Apple, Nvidia, Novo Nordisk, and Eli Lilly, pushing their stock prices to record highs in recent months.
Image source: Getty Images.
However, small- and mid-cap stocks have not been able to keep up with their large-cap peers in this skewed market, although they have not been completely ignored by investors either. But this situation could soon change -- and possibly in a dramatic way.
Despite the higher-than-expected inflation numbers for January, the Fed is still anticipated to start lowering interest rates by mid-summer. This policy change should benefit small- and mid-cap stocks.
Armed with this insight, I plan on buying this Vanguard exchange-traded fund (ETF) hand over fist this year. Read on to find out more about this incredible small-cap ETF.
A top Vanguard small-cap fund
The CRSP US Small Cap Index is a benchmark that measures the returns of small-cap stocks in the U.S. market. The Vanguard Small Cap Index Fund (VB 2.18%) is an ETF that seeks to track the performance of this index by investing in 1424 stocks that represent a broad cross-section of the small-cap universe.
One of the most attractive aspects of this fund is its exceedingly low cost of ownership. With an annual expense ratio of only 0.05%, the Vanguard Small Cap Index Fund sports a substantially lower carrying cost than its peer group, which has an average expense ratio of 1.01%.
NYSEMKT: VB
Key Data Points
The fund also follows a passive, index-based strategy that minimizes trading and turnover. The fund's turnover rate was 13.9% in its previous fiscal year, which indicates that the fund managers do not engage in frequent buying and selling of stocks.
This strategy reduces transaction costs and tax implications for the fund's investors. Moreover, research has shown that funds with low turnover rates tend to outperform funds with high turnover rates over the long term. The Vanguard Small Cap Index Fund thus has an advantage over its peers in this regard.
Another benefit of the fund is that it does not concentrate its holdings in a few stocks or sectors. The fund's largest holding, Builders FirstSource, makes up only 0.39% of the fund's assets, and no other stock accounts for more than 0.37% of its portfolio.
The fund's sector allocation is also well-balanced, with no sector representing more than 21.7% of the fund's assets. This Vanguard small-cap fund, in turn, is not exposed to excessive risk or volatility from any single stock or sector. It also enjoys the benefits of diversification by investing in a large number of small-cap stocks.
The Vanguard Small Cap Index Fund has a long track record of delivering solid returns to its stakeholders. Since its inception in 2004, the fund has returned 446% on a cumulative basis, assuming reinvestment of dividends and before taxes.
This translates to an annualized return of around 9%, which is slightly lower than the 9.7% long-term annualized return of the S&P 500. However, this comparison may not be completely fair, as the S&P 500 has benefited enormously from the stellar performance of the so-called "Magnificent Seven" over the past few years. The graph below illustrates this point:
VB Total Return Level data by YCharts.
However, if we compare the fund to its benchmark, the CRSP US Small Cap Index, we find that the fund has closely matched its performance over time, with only minor deviations. The Vanguard Small Cap Index is thus an exceptional vehicle to gain exposure to this particular cohort of stocks.
Key takeaway
Small-cap stocks could get back to their market-beating ways later this year if the Fed does indeed pivot on interest rates. To capitalize on this potentially potent catalyst, I plan on loading up on the Vanguard Small Cap Index Fund and holding it for an indefinite period.
