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The argument for investing in small-cap stocks is only getting stronger after the Fed's preferred inflation measure, the PCE index, recently confirmed a trend of cooling prices. While no policy change is expected at the conclusion of today's two-day meeting of the Federal Open Market Committee (FOMC), investors will closely analyze comments from Chair Jerome Powell and other policymakers for any concrete indications of a possible rate cut in September.
The CME FedWatch tool, widely used to gauge rate expectations, now shows a 100% chance of an interest rate cut in September, with 87.7% odds of a quarter-point reduction. These rising expectations are encouraging a shift in investor interest towards small-cap stocks, which often benefit more from lower borrowing costs due to their reliance on floating-rate financing. In the current market environment, analysts at Morgan Stanley favor small-cap growth stocks over their value counterparts.
Global Director of Research Katy Huberty explained, “Longer-duration small caps that are growth-oriented and more sensitive to changes in their cost of capital have benefitted on a relative basis as yields have come down, while small caps that are more economically sensitive (i.e., value) have not benefitted.”
Considering this trend and the inherent challenges of selecting individual small-cap stocks, the following three growth-oriented exchange-traded funds (ETFs) are notable options for those seeking small-cap exposure:
- Vanguard Small-Cap Growth ETF (VBK)
This ETF tracks the CRSP US Small Cap Growth Index, providing exposure to a diversified group of small-growth companies. It has $17.8 billion in assets under management (AUM), an average trading volume of approximately 375,000 shares, and a dividend yield of 0.68%. The expense ratio is 0.07%, and it includes over 600 holdings, with top positions in Targa Resources, Deckers Outdoor, and Axon Enterprise.
- iShares Russell 2000 Growth ETF (IWO)
IWO aims to replicate the investment results of the Russell 2000 Growth Index, focusing on U.S. small-cap stocks with growth characteristics. It has an AUM of $11.89 billion, an average trading volume of around 481,000 shares, and a dividend yield of 0.63%. The expense ratio is 0.23%, and its top holdings include Insmed Inc, Ftai Aviation, and Sprouts Farmers Market, among a total of over 1,100 holdings.
- iShares S&P Small-Cap 600 Growth ETF (IJT)
IJT targets the investment results of an index composed of small-cap U.S. equities with growth characteristics, particularly within the S&P Small-Cap 600 Index. It has $6.46 billion in AUM, an average trading volume of 124,305 shares, and a dividend yield of 0.89%. The expense ratio is 0.18%, with its top three holdings being Ensign Group, ATI, and Mueller Industries, from a total of 369 holdings.
