Three top small-cap ETFs

Small-cap stocks had a resurgence in the fourth quarter, returning 13.6% to beat the S&P 500, which gained 11.2% in the quarter. The Q4 gains for small caps constituted the bulk of the Russell 2000’s returns last year, as the benchmark was up 15% for 2023, trailing the S&P 500’s return of 24%.

Because of their low valuations relative to large-cap stocks, among other factors, analysts see small caps outperforming large-cap stocks in 2024. In its 2024 outlook, Goldman Sachs Group (NYSE:GS) said it sees the Russell 2000 gaining 15% this year, while it expects the S&P 500 to rise about 7%.

While it is always a good idea to diversify, this would be a particularly good time to add some small-cap exposure, especially for those who had been overweight in large caps. A good way to do that is through small-cap exchange-traded funds (ETFs). Small-cap ETFs cover a lot of ground, so here are a few top performers with screens designed to produce stable returns.

Invesco S&P SmallCap value with momentum ETF

The Invesco S&P SmallCap Value with Momentum ETF (NYSEARCA: XSVM) has been one of the top-performing small-cap ETFs over time, and for good reason. It is based on the S&P 600 High Momentum Value Index, which consists of 120 stocks from the S&P SmallCap 600 that have the highest value and momentum scores, based on their specific methodology. The fund is then weighted by those with the highest value scores. Ultimately, the ETF contains small caps with attractive valuations that have momentum or catalysts that are expected to drive them forward.

Currently, this Invesco ETF’s top three holdings are Fresh Del Monte Produce (NYSE: FDP), Kohls Corp. (NYSE: KSS), and Genworth Financial (NYSE: GNW).

The ETF has been a reliable performer, as it returned 20.2% in 2023. As of Dec. 31, it has a five-year annual return of 17.3% and a 10-year annual return of 10.1%. It beat the S&P SmallCap 600 index for each of those periods.

Schwab fundamental US small company index ETF

The Schwab Fundamental U.S. Small Company Index ETF (NYSEARCA: FNDA) is another small-cap ETF that has beaten the broader small-cap market over time with a more selective approach. The fund tracks the Russell RAFI U.S. Small Company Index, which includes small-cap stocks that are screened for certain fundamental measures.

Specifically, stocks are selected using three fundamental screens: adjusted sales, retained operating cash flow, and dividends plus buybacks. Based on these screens, stocks are scored and weighted in the index, and by extension, the fund. It is designed to seek out stable small caps with solid cash flow and earnings.

This Schwab ETF is much broader than the Invesco ETF listed above, as it currently has 957 holdings. The three largest positions are Abercrombie & Fitch (NYSE:ANF), EchoStar Corp. (NASDAQ: SATS), and Diversified Healthcare Trust (NASDAQ: DHC).

The ETF posted a 20.3% return in 2023 and has solid longer-term returns. Over the past five years as of Dec. 31, it has posted an annual return of 12.6%, and over the past 10 years, it has returned 8.5% on an annual basis. These results are all better than the Russell 2000 over the same periods.

iShares US Small‑Cap equity factor ETF

The iShares U.S. Small‑Cap Equity Factor ETF (NYSEARCA: SMLF) has also carved out a niche within the small-cap universe, tracking the STOXX U.S. Small‑Cap Equity Factor Index. This fund includes small-cap stocks that are selected and weighted based on four target factors: momentum, quality, value and low volatility.

The momentum criteria includes price momentum and earnings momentum. Quality is scored on gross profitability, changes in net operating assets, carbon emissions intensity, and other factors. Value is screened for book-value-to-price ratio, dividend yield, and earnings yield, among others, while low volatility is based on trailing 12-month volatility.

The portfolio currently consists of 823 holdings, with the largest positions being Builders FirstSource (NYSE: BLDR), First Industrial Realty Trust (NYSE: FR), and Jabil (NYSE: JBL).

The iShares fund was launched in 2015, so it does not yet have a 10-year track record, but in 2023, it posted a 19.7% return, and over the past five years, it has an average annual return of 11.9%, as of Dec. 31.

All three of these ETFs give you more targeted exposure to different aspects of the small-cap universe, and they have each beaten the broader small-cap benchmarks in recent years.