Today we are answering the question: What is the best small cap value ETF? If you are looking for a more traditional, low cost index ETF, VBR is the way to go. For those looking for more active fund management, AVUV is my pick.
What is Small Cap Value?
Market Capitalization Breakdown
This area of investing is of personal significance to me as I love small cap companies as well as value investing.
A small cap, or “capitalization”, ETF simply means that the ETF will only invest in stocks that are below a certain market capitalization level. There isn’t a hard and fast rule for what is small, medium, or large. But the general consensus seems to be a market capitalization of:
- Large Cap – Greater than $10bn
- Mid Cap – Between $2bn and $10bn
- Small Cap – Below $2bn and (usually) above $300m
Value Investing
The “Value” portion of a small cap value ETF means that it purchases companies that have “value” characteristics. What does this mean exactly?
There isn’t a standard definition of what a “value” stock is. But value investors tend to target companies that are trading at low valuation multiples. Some of these include companies that have:
- Low Price/Earnings Ratios
- Low Price/Book Ratios
- Low Price/Sales Ratios
- High Return on Equity
- High Dividend Yields
The general idea is that you’re buying companies that are more steady, undervalued, and are less of a “growth” stock. Growth stocks are companies that have higher multiples described above, or may not be profitable at all. But this all comes with higher prospects for growth, thus elevating their multiples.
Why Can Small Cap Value Be A Superior Investment?
Small Cap Out-performance of Large Caps
Over long periods of time, albeit not recently, small cap companies have outperformed large cap companies. Why is this? In general, it’s the level of risk associated with small cap companies. Small cap companies carry more risk as they do not have the financial might of an Apple, Amazon, PG, etc.
Therefore, when discounting cash flows and valuing small cap companies, investors place higher discount rates on them. This depresses their share prices versus larger cap companies (all else equal).
But with higher risk comes higher reward. On the aggregate, this means that investors taking more risks on small caps have been historically rewarded with higher returns.
Value Stocks vs. Growth Stocks
The data is less clear as to whether value stocks outperform growth stocks. The shift between the two is very cyclical and depends on macroeconomic factors.
However, as an investing style, value stocks are very popular with an investor looking to purchase steadier, profitable, and (in many cases) dividend paying companies. These companies tend to be the more “boring”, steady, companies versus higher growth technology companies, etc. They are also somewhat less risky in that sense and less sensitive to market downturns.
When coupled with small cap companies, value investing provides an interesting combination of riskier companies due to size, but less risky due to fundamentals.
What is the Best Small Cap Value ETF?
We’ve now established why small cap value investing can be highly effective. Let’s then answer the question: What is the Best Small Cap Value ETF?
My two favorite ETFs in this space are VBR and AVUV and both for different reasons.
Vanguard Small-Cap Value ETF – Ticker: VBR
VBR is your simple, effective, and low-cost ETF that tracks the CRSP US Small Cap Value Index. This is a very simple index that tracks a few fundamental ratios and selects companies that have “value” characteristics. This ETF is passively managed, meaning that it has a very low expense ratio of 0.07%. It is, however, less precise due to it being a more simple index fund versus this next one.
Pros: Lower expense ratio.
Cons: Possible less precise at identifying value stocks.
Avantis U.S. Small Cap Value ETF – Ticker: AVUV*
*Quick author’s note – as of writing this article, I own shares in AVUV.
AVUV is the Cadillac of small cap value ETFs and is very popular amongst value investors. This ETF is actively managed, and therefore does not track an external index. But this means it may be much more effective at identifying true “Value” stocks.
In the realm of actively managed ETFs, the expense ratio for AVUV is very reasonable at 0.25%. Performance-wise, AVUV has outperformed VBR as of writing this article. But depending on when you read this, please confirm updated performance metrics yourself.
All in all, AVUV is, in my opinion, the best small cap value ETF.
Pros: Better criteria for selecting stocks in the fund.
Cons: Higher expense ratio.
Bottom Line
So you should now know why small cap value investing is a very intriguing and potentially rewarding investment strategy. In terms of the best small cap value ETF, my personal recommendation is AVUV, but VBR does the trick as well. Hopefully this was helpful and happy investing!
DISCLAIMER – THIS ARTICLE IS NOT FINANCIAL ADVICE. THIS ARTICLE DOES NOT CONSTITUTE A BUY, SELL, OR HOLD RECOMMENDATION ON ANY SECURITY MENTIONED HERE. THIS ARTICLE CONSTITUTES MY OPINION AND NOT A STATEMENT OF FACT. ALL INFORMATION REGARDING THE FINANCIAL SECURITIES MENTIONED IS ACCURATE AS OF JANUARY 19, 2024. DO YOUR OWN RESEARCH.