Small-cap stocks are leading markets higher. With the Russell 2000 Index poised to outperform the large-cap S&P 500 on an annual basis for the first time since 2016, the Principal U.S. Small-Cap Multi-Factor Index ETF (NASDAQ: PSC) is getting in on the fun.

PSC’s underlying benchmark, the Nasdaq US Small Cap Select Leaders Index, “uses a quantitative model designed to identify equity securities (including growth and value stock) of small-capitalization companies in the Nasdaq US Small Cap Index (the ‘parent index’) that exhibit potential for high degrees of sustainable shareholder yield, pricing power, and strong momentum while adjusting for liquidity and quality,” according to Principal.

“Small-caps have gained as investors have seen bigger companies as increasingly expensive, and looked for opportunity among some of the laggards of the year. In the past three months, these four funds have gained from 26% – 30%, versus a 10.6% rise for the S&P 500,” reports Andrea Riquier for MarketWatch.

PSC Fanning the Flames of the Small-Cap Rally

PSC is higher by nearly 8% over the past month. The fund is one of the best-performing small-cap multi-factor exchange traded funds over that period, and on a year-to-date basis.

PSC is worth a look as the economy rebounds from the ill effects of the COVID-19 pandemic. While investors may flock to the relative safety of large-cap equities during a recession to lessen the blow of market volatility and provide a cushion during market downturn, small-cap performance is worth watching as the economy exits a recession. As such, investors may want to give small-cap equity funds a look now to make a factor-oriented play.

PSC YTD Performance

The size factor is one of the most durable themes in the factor space, but many investors often overlook the benefits of focusing on higher-quality, small-cap equities. While growth prospects remain compelling with smaller stocks, evidence suggests there’s waning quality in the group, potentially exposing investors to undue risk

While the quality factor often trades at a premium to value, quality stocks are usually less volatile than traditional broad market strategies, indicating some overlap with the low volatility factor.

PSC reduces some of the risk associated with smaller stocks without diminishing investors’ potential outcomes in the suddenly resurgent asset class.

For more on multi-factor strategies, visit our Multi-Factor Channel.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.