Small-caps equities can make a pronounced move to the upside. This is especially so after the recent interest rate hike pause by the U.S. Federal Reserve. It may still be a contrarian play, but one that could potentially pay off in the future if investors exercise caution and focus on value.
There are early indications that investors are starting to cycle out of safe haven assets and into riskier propositions like small-caps equities, according to a Yahoo Finance report. Large-caps equities have been the default move for the most part in 2023. They’ve had a heavy emphasis on big tech. This is because investors have been trying to balance the weight of getting growth exposure in a macroeconomic environment where rates have been elevated for longer than originally anticipated.
The primary indicator of small-caps performance is the Russell 2000. It could be signaling signs of value, according to RBC Capital Markets Head of US Equity Strategy Lori Calvasina.
“If you look at Russell 2000 valuations against S&P 500 PEs, we’re basically at the lowest level we’ve seen since the kind of ’99, 2003-type era. So the tech bubble era. And that’s causing some multi-asset investors to take notice,” she said. She noted that small-caps opportunities are best midway through a recession.
Another aspect Calvasina emphasized about bargain hunting in small-caps is fundamentals. The landscape for small-caps could also be improving when looking at their debt loads. This is especially true in a high-rate environment like now.
“We’ve been spending a lot of time walking investors through how, just like the large-cap companies, small-cap companies have really paid down their shorter term and variable rate debt,” she said. Calvasina added that smaller-caps companies “still have more of it than the big-cap companies. But just like the large-cap companies, they’ve really pivoted towards long-term debt that they’ve locked in at very, very low rates. So they’re benefiting from the era of low interest rates a bit longer than many investors have realized. So we think the balance sheet bite really isn’t as bad as feared for these companies right now.”
Of course, the challenge now is to find these companies that offer fundamental value.
Value-Focused Small-Caps Exposure
An easy way to do this is via one exchange-traded fund: the Avantis U.S. Small Cap Value ETF (AVUV). The ETF seeks long-term capital appreciation. It invests primarily in a diverse group of U.S. small-caps companies across market sectors and industry groups.
Furthermore, this fund also features a low 0.25% expense ratio that can compete with passive funds. The active component still allows for AVUV to be pliable with the current market environment as well as when conditions change in the future.
The fund has a more discerning value screener. But it’s still an ideal way to invest in the vast universe of small -caps companies while allowing for a value factor strategy to hand-pick holdings.
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