Are you looking for the next big thing in the stock market? There’s a chance it’s hiding among the small caps, because these smaller companies often remain overlooked by investors. One way to gain exposure to the entire segment of the market is to buy a small-cap ETF.

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What is a small-cap ETF?

A small-cap ETF is an exchange-traded fund that invests in the market’s smallest companies through what are called small-capitalization, or small-cap, stocks. Small-cap ETFs give you an easy way to buy the small-cap “haystack” rather than search through it for the high performers.

Small-cap stocks may sound small, but they’re not usually that tiny. The total value of all their shares outstanding is typically between a few hundred million dollars and a few billion dollars. That’s small for the stock market, though, where market capitalization can hit a trillion dollars.

Investors like small caps because they can offer higher potential returns than large-cap stocks, which are typically represented by the S&P 500 index. However, because they’re smaller and have fewer financial resources, they’re often riskier and more volatile, too.

Because of these risks, investing in individual small stocks is better left to more advanced investors. But even newer investors can buy a basket of these companies through a small-cap ETF and take advantage of the potential higher returns in undiscovered small stocks.

Top-performing small-cap ETFs

Bankrate selected its top funds based on the following criteria:

  • U.S. funds that appear in ETF.com’s screener for small-caps (growth, value, blend)
  • Funds among the top performers over the last five years
  • Performance measured on March 31, 2023 using the most recent figures from Morningstar.

Invesco S&P SmallCap 600 Revenue ETF (RWJ)

This ETF is based on the S&P SmallCap 600 Revenue-Weighted Index, which re-weights stocks of the S&P SmallCap 600 Index by a company’s revenue.

  • 2023 YTD performance: 1.5 percent
  • Historical performance (annual over 5 years): 11.4 percent
  • Expense ratio: 0.39 percent

Invesco S&P SmallCap Value with Momentum ETF (XSVM)

This ETF tracks the S&P 600 High Momentum Value Index, which is composed of 120 stocks with the highest scores on momentum and value factors.

  • 2023 YTD performance: -2.0 percent
  • Historical performance (annual over 5 years): 10.8 percent
  • Expense ratio: 0.36 percent

Pacer U.S. Small Cap Cash Cows 100 ETF (CALF)

This ETF includes the top 100 stocks in the S&P SmallCap 600 based on their free cash flow yield.

  • 2023 YTD performance: 4.3 percent
  • Historical performance (annual over 5 years): 8.8 percent
  • Expense ratio: 0.59 percent

Invesco DWA SmallCap Momentum ETF (DWAS)

This ETF is based on stocks in the Dorsey Wright SmallCap Technical Leaders Index, which includes stocks with strong momentum.

  • 2023 YTD performance: -0.4 percent
  • Historical performance (annual over 5 years): 8.2 percent
  • Expense ratio: 0.60 percent

ALPS O’Shares U.S. Small-Cap Quality Dividend ETF (OUSM)

This ETF tracks the performance of the O’Shares U.S. Small-Cap Quality Dividend Index, which includes stocks that exhibit low volatility, dividend growth and high-quality fundamentals.

  • 2023 YTD performance: 3.9 percent
  • Historical performance (annual over 5 years): 8.2 percent
  • Expense ratio: 0.48 percent

Invesco Russell 2000 Dynamic Multifactor ETF (OMFS)

This index fund includes stocks from the Russell 2000 index and weights them according to the economic cycle and the state of the market, assigning them one of five investment styles (value, momentum, quality, low volatility and size).

  • 2023 YTD performance: 1.5 percent
  • Historical performance (annual over 5 years): 7.9 percent
  • Expense ratio: 0.39 percent

JPMorgan Diversified Return U.S. Small Cap Equity ETF (JPSE)

This fund tracks the JP Morgan Diversified Factor U.S. Small Cap Equity Index.

  • 2023 YTD performance: 1.1 percent
  • Historical performance (annual over 5 years): 7.6 percent
  • Expense ratio: 0.29 percent

VictoryShares U.S. Small Cap High Dividend Volatility Weighted ETF (CSB)

This ETF tracks the performance of the Nasdaq Victory U.S. Small Cap High Dividend 100 Volatility Weighted Index.

  • 2023 YTD performance: -0.2 percent
  • Historical performance (annual over 5 years): 7.5 percent
  • Expense ratio: 0.35 percent

Invesco S&P SmallCap Momentum ETF (XSMO)

This ETF is based on the S&P SmallCap 600 Momentum Index, which includes 120 stocks in the S&P SmallCap 600 Index having the highest “momentum scores.”

  • 2023 YTD performance: -3.1 percent
  • Historical performance (annual over 5 years): 7.4 percent
  • Expense ratio: 0.37 percent

Nuveen ESG Small-Cap ETF (NUSC)

This ETF tracks the TIAA ESG USA Small-Cap Index, which includes small companies in the U.S. that satisfy certain ESG (environmental, social and governance) criteria.

  • 2023 YTD performance: 1.8 percent
  • Historical performance (annual over 5 years): 7.1 percent
  • Expense ratio: 0.31 percent

Are small-cap ETFs a good investment?

Investing in small-cap ETFs can provide attractive returns as long as they’re purchased at sensible prices, but there are some drawbacks to be aware of.

Small-cap ETFs allow you to purchase a diversified portfolio of smaller companies for a relatively low cost. They also won’t require the extensive research that investing in individual companies does and can be added to your overall portfolio quickly to boost exposure to the small-cap universe. Small caps can generate high returns as they grow and become larger businesses. Many of today’s most successful companies started as small caps.

But one drawback of investing in small-cap ETFs is that as the most successful companies grow, they move on from being considered small-cap and many funds are forced to sell them to stay in line with their investment objectives. You also won’t get the broad diversification that comes with other funds, so if an economic development negatively impacts the small-cap universe, you won’t be protected. Small-cap funds also tend to be more volatile than funds that hold larger, more established companies.

(You may also want to check our list of the best large-cap ETFs.)

Bottom line

Small-cap ETFs are an attractive way to invest in some of the market’s fastest-growing companies at low cost without the same risks of buying individual stocks. But like all investments in the stock market, they aren’t without risk and other drawbacks.

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.