In recent years, small-cap ETFs have struggled amid rising interest rates, as central banks sought to combat post-COVID inflation. These funds, which focus on smaller companies, tend to be more sensitive to higher borrowing costs.
However, a shift may be on the horizon. With the U.S. Federal Reserve and other central banks starting to ease rates, the economic environment could become more favorable for smaller businesses—potentially making small-cap ETFs more appealing to investors once again.
Investor Interest in Small-Cap ETFs Soars
According to Trackinsight data, there's been a big jump in interest for small-cap ETFs this year, with $13.53 billion flowing in this past month alone, and $20.02 billion so far this year. U.S. small-cap ETFs are leading the way, pulling in $11.44 billion in just a month, followed closely by small-cap stocks from developed markets, which brought in $10.72 billion.
So why the rising interest in small cap funds?
Why Small-Cap Stocks Tend to Shine When Interest Rates Drop
Small-cap stocks are particularly attractive in low-interest rate environments for several reasons.
Lower Borrowing Costs for Growth
First, lower borrowing costs allow these companies, which often depend on external financing for growth, to invest more in expansion and innovation without the burden of high interest payments. This can lead to improved profitability and higher stock valuations.
Sensitivity to Interest Rates
Additionally, small caps are generally more sensitive to interest rates than large caps; they typically hold more floating-rate debt and have weaker balance sheets, making them more vulnerable to rising costs of capital.
Agility and Adaptability
Moreover, smaller companies tend to be more agile and adaptable than their larger counterparts. Their size allows for quicker decision-making processes and a greater ability to pivot in response to market changes or emerging trends.
This agility enables small caps to seize new opportunities and innovate rapidly, which can drive growth and enhance competitive advantages. As interest rates decline, investor risk appetite tends to increase, leading to greater flows into small-cap stocks as they become more appealing compared to larger, more established companies.
Overall, the combination of lower financing costs, enhanced growth potential, and agility positions small caps favorably when rates are low.
Here is a list of options to consider if you're a US-based investor:
Top 5 largest small cap ETFs by assets under management (As of Sep. 26, 2024)
- iShares Core S&P Small-Cap ETF (NYSE:IJR): $84.64B
- iShares Russell 2000 ETF (NYSE:IWM): $68.73B
- Vanguard Small-Cap Index Fund ETF (NYSE:VB): $59.81B
- Vanguard Small-Cap Value Index Fund ETF (NYSE:VBR): $30.31B
- Vanguard Small-Cap Growth Index Fund ETF (NYSE:VBK): $17.84B
Top 5 cheapest small cap ETFs by expense ratio
- SPDR® Portfolio S&P 600™ Small Cap ETF (NYSE:SPSM): 0.03%
- BNY Mellon US Small Cap Core Equity ETF (NYSE:BKSE): 0.04%
- Schwab U.S. Small-Cap ETF (NYSE:SCHA): 0.04%
- iShares Morningstar Small-Cap ETF (NYSE:ISCB: 0.04%
- Vanguard Small-Cap Index Fund ETF (NYSE:VB): 0.05%
Top 5 small cap ETFs by net inflows year-to-date (As of Sep. 26, 2024)
- Vanguard Small-Cap Index Fund ETF (NYSE:VB): +$4.00B
- Avantis US Small Cap Value ETF (NYSE:AVUV): +$3.91B
- iShares Core S&P Small-Cap ETF (NYSE:IJR): +$2.92B
- Pacer US Small Cap Cash Cows 100 ETF (NYSE:CALF): +$2.83B
- Vanguard Russell 2000 Index Fund ETF (NASDAQ:VTWO): +$2.81B
Here is a list of options to consider if you're a European investor:
Top 5 largest small cap ETFs by assets under management (As of Sep. 26, 2024)
- iShares MSCI World Small Cap UCITS ETF USD (LON:WLDS): $4.25B
- SPDR® Russell 2000 US Small Cap UCITS ETF (LON:R2US): $3.29B
- X-Trackers MSCI Europe Small Cap UCITS DR 1C (LON:XXSC): $2.00B
- iShares S&P Small Cap 600 UCITS (LON:IDP6): $2.00B
- iShares VII PLC - iShares MSCI USA Small Cap ESG Enhanced ETF USD (BIT:CSUSS): $1.74B
Top 5 cheapest small cap ETFs by expense ratio
- JPMorgan (NYSE:JPM) BetaBuilders US Small Cap Equity ETF USD Income (LON:BBSD): 0.14%
- Invesco S&P SmallCap 600 UCITS ETF (LON:USML): 0.14%
- JPM BetaBuilders US Small Cap Equity UCITS ETF - USD (LON:BBSC): 0.14%
- iShares STOXX Europe Small 200 UCITS ETF (DE) – EUR (EXSE) : 0.2%
- Credit Suisse (SIX:CSGN) ICAV - CSIF (IE) MSCI USA Small Cap ESG Leaders (BIT:USSMC): 0.2%
Top 5 small cap ETFs by net inflows year-to-date (As of Sep. 26, 2024)
- db x-trackers MSCI Europe Small Cap UCITS DR 1C (LON:XXSC): +$802M
- SPDR® Russell 2000 US Small Cap UCITS ETF (LON:R2US): +$669M
- iShares STOXX Europe Small 200 UCITS ETF (DE) – EUR (EXSE): +$423M
- iShares MSCI World Small Cap UCITS ETF USD (LON:WLDS): +$414M
- iShares S&P Small Cap 600 UCITS (LON:IDP6): +$367M