An Effective Avenue for Small-Cap Exposure | ETF Trends

The Vanguard Small Cap ETF (NYSEArca: VB), which tracks the CRSP US Small Cap Index, is one of the largest ETFs offering access to smaller stocks. It is also one of the most liquid and least expensive options for small-cap access, explaining why this fund is beloved by advisors and investors.

Due to the domestic focus of small-cap companies, it was also believed these stocks would be less vulnerable to global trade spats, but recent price action in the group suggests otherwise. However, small-cap stocks were among the first assets to enter bear markets when U.S. markets tumbled in the fourth quarter.

To its credit, the Vanguard small-cap ETF is up 16.51% year-to-date and 2.51% this month.

“Most of these small-cap names haven’t established durable competitive advantages and tend to be riskier than their large-cap counterparts,” said Morningstar in a recent note. “But this fund’s broad reach helps it effectively diversify firm-specific risk. Market-cap weighting relies on the information aggregated in stock prices to weight its holdings. Most of the time, the risks of portfolio concentration that may sully index funds are more than offset by the cost advantage and efficiency gained from market-cap-weighting.”

What’s Next for Small Caps?

Small-cap stocks may also be lacking near-term catalysts and the levered nature of some smaller companies could leave small caps vulnerable if the business cycle turns.

VB holds nearly 1,400 stocks with a median market value of $4 billion. The small-cap fund allocates 26.40% of its weight to the financial services sector while industrial and technology names combine for almost 32% of the ETF’s roster. Importantly, VB has been a durable long-term performer.

“During the trailing decade through June 2018, this fund bested the category average by 2.4 percentage points per year with similar volatility. Much of this relative outperformance can be attributed to the fund’s cost advantage and the efficiency of market-cap weighting. Because this index fund is always fully invested, it suffered a larger drawdown than the category average during the financial crisis. But its smaller cash drag pays off during bull markets,” according to Morningstar.

VB, which charges just 0.05% per year, or $5 on a $10,000 investment, garners a Gold rating from Morningstar.

For more information on the markets, visit our current affairs category.