For decades, one of the most potent factor combinations was small-cap value. However, some investors may have lost sight of that fact through years of large-cap growth taking the cake among factor pairings. That situation probably worsened in recent years as small-caps broadly disappointed relative large-cap equities.
On the other hand, this debate is a case of methodology mattering. Take the case of the Avantis U.S. Small Cap Value ETF (AVUV). For the three years ending May 8, the actively managed fund returned 25.6%. During that period, the Russell 2000 and the S&P SmallCap 600 indexes as well as the value offshoots of those gauges posted negative showings.
That confirms that when executed properly, active management is additive in the small-cap value equation. Those are likely reasons why it’s taken less than five years for AVUV to become an $11.1 billion ETF. It’s also likely why it’s one of the top asset gatherers this year among all actively managed equity-based ETFs.
Small-Cap ETF AVUV Advantages Could Shine Bright
One of the widely cited criticisms of small-cap investing via the passive wrapper is that most of the traditional indexes deployed to track smaller stocks don’t take profitability, or lack thereof, into account. Many passive small-cap ETFs are homes to many companies that don’t make any money. That can be a drag on a performance. Conversely, as an active ETF, AVUV can take steps to mitigate that risk.
“Since the Great Financial Crisis, large-caps de-levered and got their debt under control because… well, they had to. Smaller firms saw their debt relative to earnings actually increase. Small-caps have been saddled with debt as leverage trended up in the last decade, dampening their benefits as a buy-and-hold,” according to BlackRock research.
Another advantage in AVUV’s active approach is that active managers can be more responsive to interest rate trends than passive funds. The ETF allocates just 7% of its portfolio to tech and healthcare stocks. Those are corners of the small-cap universe that have been pressured by higher interest rates.
AVUV isn’t heavily allocated to small-cap segments that have been vulnerable to high borrowing costs. But it has healthy exposure to sectors, including consumer discretionary and industrials, that could benefit from more accommodative monetary policy.
“Small-caps could also see tailwinds from rate cuts, which could lower the cost of their relatively high debt burden,” added BlackRock.
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