The Vanguard S&P 500 ETF (VOO 0.15%) has long been a popular choice for index investors due to its low expense ratio and ability to track the S&P 500 index effectively. This year, the ETF has provided shareholders with a return of approximately 17%, largely driven by a few mega-cap stocks within the fund. However, while these returns have been impressive, the rest of the market has remained relatively flat, with certain segments experiencing significant declines.
Before investing in or adding to your position in the Vanguard S&P 500 ETF, it may be worth considering three alternative ETFs that focus on segments of the market that have been beaten down recently but have historically outperformed the S&P 500. These ETFs offer attractive opportunities at current prices.
One such opportunity lies in small-cap stocks, which have historically outperformed large-cap stocks, particularly small-cap value stocks. These stocks are currently trading at extremely low valuations. The S&P 600, which tracks profitable small-cap companies, currently has a low P/E ratio of around 11.6, a valuation seldom seen in the past 15 years.
However, it is important to note that there are valid reasons for the low valuations of small-cap stocks. Small caps are more vulnerable to economic downturns than large caps, as they are more likely to go out of business in such circumstances. Additionally, small caps are more affected by interest rate changes, as they rely more on debt for growth. With the Federal Reserve’s establishment of “higher-for-longer” interest rates, small caps have experienced significant struggles.
Despite these challenges, there are indications that the tide may be turning for small caps. The possibility of the Fed ceasing to raise interest rates and even potentially lowering rates in the near future could provide relief for small-cap companies, leading to stronger earnings growth.
To take advantage of the potential opportunity in small caps, investors may consider three ETFs. The first is the SPDR Portfolio S&P 600 Small Cap ETF (SPSM 1.07%), which focuses on profitable small caps with market caps between $850 million and $5.2 billion. It has the lowest expense ratio among its peers that track the S&P 600 index.
Another option is the Vanguard Small-Cap Value ETF (VBR 1.06%), which tracks the CRSP US Small Cap Value Index. This index includes companies in the bottom 15% of publicly traded stocks by market cap. The Vanguard ETF has a lower expense ratio compared to other small-cap value index funds and has historically outperformed small caps and the overall market.
For investors seeking a more actively managed approach, the Avantis US Small Cap Value ETF (AVUV 1.76%) may be worth considering. This ETF buys stocks in the Russell 2000 index that are trading at good value with strong profitability characteristics. The Avantis ETF has been able to weather the storm in the small-cap market over the past two years and has a modest expense ratio of 0.25%.
Given the current concentration in the S&P 500, diversifying into smaller companies through these ETFs could be a wise move for index fund investors.
