- The U.S. Small Cap Blend asset class has been one of the most profitable equity asset classes for over 45 years
- The oldest available Small Cap Blend ETF has outperformed an S&P 500 index fund by a whopping 4.45% CAGR over the last 18 years
- There are currently 42 ETFs available in the Small Cap Blend Morningstar category. Eleven of these ETFs have been available for 10 years or longer
- Five of these older ETFs have outperformed an S&P 500 index fund since their inception dates
U.S. Small Cap Blend vs U.S. Large Cap Blend (aka S&P 500)
Source: https://www.portfoliovisualizer.com/
One of the reasons given for the persistent outperformance of small cap stocks over large cap stocks is that investors receive a premium for the added risk and volatility. I agree that small cap stocks tend to be more volatile, but the additional volatility is relatively insignificant over long periods. For example, in the chart above, notice that the max drawdown in small cap stocks was only 3% more than large cap stocks. Also, note that the worst single-year performance was worse for large cap stocks. Although small cap stocks have a slightly higher standard deviation (more volatility), they have consistently outperformed large cap stocks during the same period. For these and other reasons, it is my opinion that small cap blend equities should be a core position in the equity portion of investors’ portfolios.
Now, let’s focus on modern history and investigate how Small Cap Blend ETFs have performed since 2000. ETFs have a relatively short history compared to the entire market history, but fortunately the oldest available ETF in this category has been available for over 18 years. The iShares Core S&P Small-Cap ETF was created on May 22, 2000. Since its’ inception date, this ETF has significantly outperformed an S&P 500 index fund.
IJR vs S&P index fund: June 2000 – November 2018
Source: https://www.portfoliovisualizer.com/
IJR vs SPY: May 26, 2000 – December 30, 2018
Source: https://www.koyfin.com/home
The IJR ETF is a good fund, but there are currently 41 other ETFs available in the Morningstar Small Cap Blend category. Eleven of these ETFs have been available for at least 10 years. In the chart below, I have ranked these older ETFs by their performance by comparing each one head-to-head. The top 4 Small Cap Blend ETFs only have 0.59% CAGR difference in long-term performance. Therefore, these rankings can change daily; which is okay because this means investors will probably get about the same performance by investing in any one of these 4 ETFs. I did not consider valuations, investor suitability, tax efficiency, volatility or any other metric than performance when creating this ranking chart. Investors should perform their own due diligence.
Source: https://www.morningstar.com/
The top 4 Small Cap Blend ETFs were SLY, IJR, PRFZ and EES. Vanguard’s VB ETF gets an honorable mention because is has performed well and has also outperformed an S&P 500 index fund since inception. Due to some of the limitations of the back-testing tools that I use, the following comparison charts will only focus on the top 4 Small Cap Blend ETFs.
SLY vs IJR vs EES vs PRFZ: March 2007 – November 2018
Source: https://www.portfoliovisualizer.com/
SLY vs IJR vs PRFZ vs EES vs SPY: February 23, 2007 – December 30, 2018
Source: https://www.koyfin.com/home
Now that we’ve seen how well these top 4 Small Cap Blend ETFs have performed, let’s turn our attention to what you’re getting when you invest in one of these funds. Below you can read the stated objectives and descriptions of these ETFs.
SLY – The SPDR® S&P® 600 Small Cap ETF seeks to provide investment results that, before fees and expenses, correspond generally to the total return performance of the S&P® SmallCap 600 IndexSM (the “Index”). The selection universe for the S&P SmallCap 600 Index includes all U.S. common equities with market capitalizations generally between $450 million and $2.1 billion at the time of inclusion. The Index is float-adjusted and market capitalization weighted. (Best long-term performance)
IJR – The iShares Core S&P Small-Cap ETF seeks to track the investment results of an index composed of small-capitalization U.S. equities. Exposure to U.S. small cap stocks. Low cost and tax efficient. Use at the core of a portfolio to seek long-term growth. (Lowest volatility, best 15-year performance, oldest track record, lowest expense ratio, largest AUM)
EES – WisdomTree U.S. SmallCap Earnings Fund seeks to track the investment results of earnings-generating small-cap companies in the U.S. equity market. Learn more about the Index that EES is designed to track. Gain broad U.S. small cap equity exposure to profitable companies. Use to complement or replace small cap active and passive strategies with the potential for more favorable valuations. (Lowest correlation to US markets, lowest P/E & P/B, highest dividend yield)
PRFZ – The Invesco FTSE RAFI US 1500 Small-Mid ETF (Fund) is based on the FTSE RAFI US 1500 Small-Mid Index (index). The Fund will normally invest at least 90% of its total assets in common stocks that comprise the Index. The Index is designed to track the performance of small and medium-sized US companies. Companies in the index are selected based on the following four fundamental measures of size: book value, cash flow, sales and dividends. Each of the equities with a fundamental size ranking of 1,001 to 2,500 in the universe of 3,000 is then selected and assigned a weight equal to its fundamental value. The Portfolio and the Index are reconstituted annually. (Best single-year performance, most diversified (1441 stocks))
U.S. Small Cap Blend equities should be a core position of investors’ equity portfolios. There are 41 ETFs to choose from in this asset class, but history has shown us that there can be substantial performance differences in funds that track the same universe of stocks. One of the primary factors that can help investors to choose a better fund is to observe past performance. Another important factor is to look at which index an ETFs is tracking. There are significant differences between the Russell 2000 and the S&P 600 small cap blend indexes. Index Fund Advisors published an excellent article on these differences right here: Small-Cap Face-Off: Russell 2000 vs. S&P 600. With the evidence provided, it is my opinion that investors will do well in any of the top 5 funds in this category: SLY, IJR, EES, PRFZ or VB.
Thank you for taking time to read this article. If you found it useful, please share it with a friend.
Respectfully yours, Micah McDonald, aka the Deep Value ETF Accumulator
Disclosure: We own shares of EES and we intend to buy more shares in the future. I am not a professional investment advisor. Please perform your own due diligence or seek assistance from a Registered Investment Advisor prior to investing in any fund mentioned in this article.
Previous Deep Value ETF Accumulator article on the U.S. Small Cap Blend asset class: FEBRUARY 12, 2018 Best Long-Term Performance U.S. Small Cap Blend ETFs