5 Best Small-cap Index Funds

Traders or investors looking for growth potential in their portfolios should take a hard look at small-cap index funds. In this article, we explain why this is the case and introduce the top five small-cap index funds. 

Small Cap Explained 

Small-cap companies have market capitalizations from $300 million to $2 billion ^[1]. Market capitalization represents the fair market value of the outstanding shares of any company that trades on a stock exchange. Small-cap shares tend to perform well in a bull market. 

A small-cap index fund is an exchange-traded fund (ETF) or a mutual fund that is made up of a basket of companies that are in a small-cap index. A good example of a small-cap index is the Russell 2000 (RUSSELLINDICES: RUT). 

Why Investing in Small Cap Is A Good Idea 

Small-cap stocks tend to potentially have better returns in a bull market than their large-cap counterparts. The chart below shows the comparative cumulative returns since 2002 between small-cap and large-cap shares. The chart shows that in an upward-trending market environment, small-caps shares tend to outperform large-caps on average. This finding suggests that it may be a good idea to have a portion of your portfolio invested in small-cap stocks.  

A bull market is defined as an extended period where stock prices are rising, and in this market condition, prices of small-cap shares can rise faster than the overall economy. This can last for months or even years, and during this time, small-cap stocks typically outperform large-cap stocks. 

There are several reasons for this phenomenon. First, small-cap companies are typically more nimble and agile than their larger counterparts, which allows them to take advantage of opportunities more quickly. Second, small-cap stocks are often overlooked by investors, which means they may be undervalued relative to large-cap stocks. 

If you’re looking to add some small-cap stocks to your portfolio, one way to do it is through a small-cap index fund. These funds invest in a basket of small-cap stocks and provide diversification within this asset class. 

While there is no guarantee that small-cap stocks will continue to outperform in a bull market, history has shown that they tend to do so. 

There are many benefits to consider investing in small-cap index funds: 

• Diversification across Market Caps: Diversification is the cornerstone of building a good investment portfolio. The modern portfolio theory has proven that investors can minimize volatility while sustaining portfolio returns by allocating funds across different market capitalizations, asset classes and market sectors.  
• Diversification over market sectors: Investing in a small-cap index fund exposes your portfolio to a wide range of small-cap stocks across different sectors. Small-cap stocks carry a higher degree of risk than large-cap stocks due to the cyclical nature in which they tend to move. In addition, they are more volatile than large-cap stocks. Investing in an index fund is the simplest way of reducing the risk on closed-loop stocks by diversifying your investment among several dozen companies. 
• Better returns in a bull market: Small-cap shares have historically outperformed those of large-caps due to their greater capacity for price expansions, especially in a bull market. 

Top Five Small Caps Index Funds 

In choosing the best small-cap index funds, we have taken the quantitative approach using the following criteria: 

• Metric 1: Outperforms the Russell 2000 benchmark based on the buy-and-hold strategy, computed on daily closing prices for the 12 months ending October 31, 2022. 
• Metric 2: Outperforms the Russell 2000 benchmark based on lower volatility. 
• Metric 3: Outperforms the Russell 2000 benchmark based on higher Sharpe ratios 

Using these three metrics against Russell 2000 as a benchmark, we have chosen the top performing five small-cap index funds and ranked them accordingly. 

The following table summarizes the important facts: 

1. VBR 

   1. Managed by Vanguard, VBR has a dividend yield of 1.95%, and an expense ratio of 0.070%, and total assets under management of $25.12 billion. 
   2. The VBR ETF has a passive management style and tracks the CRSP US Small Cap Value Index, which measures the investment return of small-cap value stocks, and provides a convenient way to match the performance of a diversified group of value companies. The fund also operates in a way to invest in small-cap shares that are part of the CRSP US Small Cap Value Index so that it fully replicates the index. 

2. SPDR S&P 600 Small Cap ETF (SLY) 

   1. SLY ETF is part of the SPDR State Street Global Advisors family of funds, and it has a dividend yield of 1.63%, and an expense ratio of 0.150%, and total assets under management of $1.7 billion. 
   2. The SLY ETF is designed to include the same companies in the S&P Small Cap 600 Index, and therefore its return closely matches that of the S&P Small Cap 600 Index (a market capitalization-weighted index) before fees and expenses. 

3. iShares Core S&P Small-Cap ETF (IJR) 

   1. Managed by iShares, IJR has a dividend yield of 1.68%, an expense ratio of 0.060%, and total assets under management of $68.95 million. 
   2. The IJR ETF uses the same underlying index as the SLY ETF above, the S&P Small Cap 600 Index. It has investment results that correspond to the performance of the S&P Small Cap 600 Index before fees and expenses. 

4. Vanguard Small Cap ETF (VB)

   1. Managed by Vanguard, VB has a dividend yield of 1.52%, an expense ratio of 0.050%, and total assets under management of $42,69 billion.  
   2. Similar to VBR, THE VB ETF also tracks the performance of the CRSP US Small Cap Index, which measures the investment return of small-cap stocks. 

5. Schwab U.S. Small-Cap ETF (SCHA) 

   1. Managed by Schwab Asset Management, SCHA has a dividend yield of 0.82%, an expense ratio of 0.040%, and total assets under management of $13,99 billion. 
   2. The fund invests at least 90% of its net assets in stocks that are part of the Dow Jones U.S. Small-Cap Total Stock Market Index. It tracks the total return of the Dow Jones U.S. Small-Cap Total Stock Market Index before fees and expenses as closely as possible. 

Trade with Vantage 

Investing in small-cap CFDs on shares comes with higher risks when compared to the blue chips, but the small-cap nature gives the shares more rooms for upside during a bull market. However, it is essential to note that the small-cap sector is greatly influenced by fluctuations in the market, which makes the stocks highly volatile. As a result, small-cap stocks tend to perform well during market uptrends and underperform when the market struggles. 

If you decide to invest or trade, you can and should protect yourself from the market’s volatility by learning about the market, practicing in the demo account, and having a solid risk management approach. In addition to looking for companies with good reputations and a history of success, you should do your research and only invest in what you are comfortable with. 

Vantage is an award-winning multi-asset CFD broker and has received numerous prestigious awards in recognition as one of the best in the financial markets. As a leading multi-asset CFD trading broker, Vantage is robustly regulated and is committed to uphold the highest regulatory and compliance standards.