Small-cap stocks are trading at valuations that many investors find attractive, and momentum strategies could help unlock their potential. A recent report highlights how these often-overlooked equities are looking cheap, presenting an opportunity for those willing to look beyond the mega-cap giants. Here are three momentum-focused ETFs that might be worth a closer look.

Why Small-Cap Stocks Are Getting Attention

The current market landscape is unusual. While large-cap indices have been boosted by a handful of tech behemoths, many smaller companies have been left behind. This divergence has created a valuation gap that some analysts believe is too wide to ignore. Historically, periods of significant undervaluation in small caps have often preceded strong rebounds.

Moreover, small-cap companies tend to be more domestically focused, making them less vulnerable to global trade tensions and currency fluctuations. With the domestic economy showing resilience, these firms could be poised for growth as investor sentiment shifts. The key is selecting the right vehicles to capture this potential, which brings us to momentum ETFs.

What Is Momentum Investing?

Momentum investing is a strategy that capitalizes on existing trends. Instead of buying undervalued stocks that have yet to move, momentum investors buy stocks that are already rising, betting that the trend will continue. This approach can be particularly effective in small-cap segments, where price movements are often more pronounced and trends can persist longer.

ETFs that focus on momentum screen for stocks with strong recent performance and hold them in a diversified portfolio. This removes the guesswork of picking individual winners and provides exposure to a basket of high-flying small caps. For investors who want to combine value and momentum, these funds offer a compelling blend.

  • Diversification: Spread risk across many companies.
  • Discipline: Systematic rules remove emotional bias.
  • Efficiency: Low-cost access to a sophisticated strategy.

Three Momentum ETFs to Consider

While we cannot endorse specific funds, several ETFs have stood out for their momentum approach and small-cap focus. These funds typically rank stocks based on price performance and other factors, then weight them accordingly. Here are three examples that have been highlighted in recent analyses.

iShares Edge MSCI USA Size Factor ETF (SIZE)

This ETF focuses on small and mid-cap stocks that exhibit strong momentum characteristics. It uses a factor-based approach that seeks to capture the performance of companies with high price momentum, while also considering other factors like quality and volatility. With a low expense ratio, it is an efficient way to gain exposure to this segment.

Vanguard Small-Cap Growth ETF (VBK)

While not a pure momentum fund, VBK tilts toward growth-oriented small caps, which often show strong momentum. The fund tracks the CRSP US Small Cap Growth Index, which includes companies with strong earnings growth and price appreciation. Its low costs and broad diversification make it a favorite among long-term investors.

Avantis U.S. Small Cap Equity ETF (AVSC)

Avantis is known for its systematic approach, and AVSC is no different. This ETF screens for small-cap stocks with high expected returns, which includes momentum and profitability factors. It offers a more sophisticated take on small-cap investing, with a value tilt that could complement a momentum strategy.

Each of these funds has its own methodology, but all share a common theme: they are designed to capture the upside of small-cap stocks that are gaining traction. Investors should do their own research to determine which fits their risk tolerance and investment goals.

Risks and Considerations

Momentum investing is not without risks. When market trends reverse, momentum stocks can suffer sharp losses. Small caps, in particular, are more volatile than their larger counterparts. Additionally, momentum strategies can underperform in certain market environments, such as during sharp economic downturns.

It is also important to consider the expense ratios and trading costs of these ETFs. While most are affordable, high turnover in momentum strategies can lead to higher capital gains distributions. Investors should also be mindful of the tax implications of frequent trading.

Finally, no single strategy is a silver bullet. Combining momentum with other factors, such as value or quality, can help mitigate risks. A well-diversified portfolio that includes both large and small caps, growth and value, is often the best approach for long-term success.

Key Takeaways

Small-cap stocks are looking cheap, and momentum ETFs offer a way to potentially profit from their recovery. By focusing on companies with strong recent performance, these funds aim to capture trends that could persist. However, investors should be aware of the risks and consider how these ETFs fit into their overall strategy.

As always, it is wise to consult with a financial advisor before making any investment decisions, especially in volatile segments like small-cap equities.

With careful selection and a long-term perspective, these momentum ETFs could be a valuable addition to a diversified portfolio.