As the factor investing crowd tilt towards value and fundamental analysis, small- and mid-cap ETFs like the Invesco FTSE RAFI US 1500 Small-Mid ETF (PRFZ) can thrive.

Small- and mid-cap equities have been going strong since the move toward Covid-19 vaccinations. While the space may have taken a breather the past month, more strength in 2021 could be had using fundamental analysis to screen for quality equities.

Small-company stocks have had a good run as the U.S. economy slowly recovers from the Covid-triggered recession,” a Barron’s report noted. “That’s in the aggregate, though—many investors may be seeing a wide range of returns in their portfolios.”

That strategy is inherent in PRFZ, which is based on the FTSE RAFI US 1500 Small-Mid Index (Index).

The Index is designed to track the performance of small- and medium-sized US companies. Companies in the index are selected based on the following four fundamental measures of size: book value, cash flow, sales, and dividends. Each of the equities with a fundamental size ranking of 1,001 to 2,500 in the universe of 3,000 is then selected and assigned a weight equal to its fundamental value.

PRFZ Chart

A Recovery Rife with Value

A recovering economy can be a boon for value pickers. One of the advantages of mid- and especially small-cap equities is their propensity for high beta, moving in close lockstep with the broad market changes.

“Year to date, returns of the nearly 600 small-cap funds have ranged from a 5% loss to a 65% gain,” the article said further. “Active managers, though they often lag behind their benchmarks, have seen particularly strong performance this year: About two-thirds of small-cap active funds are outperforming, the highest rate since at least 2015, according to Bank of America strategist Jared Woodard.”

“Recoveries have historically been the best time for stockpickers, says Woodard, especially for the highly cyclical small-cap companies, which respond fastest to changes in the economy,” the article added.

“Managers are having an easier time making informed choices, while benchmarks cannot respond in such a dynamic way,” he told Barron’s.

Small caps receded from their strong performance early in 2021, but that could be opening up some opportunities.

“What’s more, despite the recent rally, small-caps remain cheaper than their larger peers,” the article said. “The discount further widened last month as the group experienced some pullback. Active managers can be more selective in terms of valuation.”

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