Morningstar spotlights five undervalued small-cap ETFs

Morningstar has spotlighted five undervalued small-cap exchange-traded funds (ETFs) that offer attractive opportunities amid declining interest rates. At the same time, the investment research company urges investors to tread carefully and be selective. 

Morningstar analyst Zachary Evens believes the U.S. market has several small-cap ETFs that remain undervalued. He has highlighted five, each of which “may offer compelling upside.”

— iShares S&P Small-Cap 600 Value ETF. This passively managed ETF specializes in micro caps (with market capitalization between $50 million and $300 million) included in the S&P Small-Cap 600 and invests primarily in value stocks. Note that unlike growth stocks, which are selected because they are outperforming the market, value stocks have strong fundamentals but are undervalued and cheaper than peers. As of February 14, investors had almost $7.6 billion in this ETF.

— Dimensional US Small Cap Value ETF, which has $4.4 billion in assets, also focuses on small-cap value stocks. Among its holdings are airline Alaska Air and United States Steel, the latter of which is likely to benefit from increased tariffs on steel imports to the U.S. under the Trump administration.

— Avantis US Small Cap Equity ETF is an actively managed fund positioned for long-term capital appreciation, according to its description. It invests at least 80% of assets in U.S. small caps. The fund currently has $6 billion in assets.

— Avantis US Small Cap Value ETF has $16 billion in assets under management. Its top three sector exposures are financials, industrials, and consumer discretionary (which includes nonessential consumer goods such as luxury items, cars, and household appliances).

— Dimensional US Targeted Value ETF invests at least 80% of assets in shares of smaller U.S. companies, according to its investment policy. It has $12 billion in assets under management.

Investing in ETFs that track the Russell 2000, Russell Microcap, or S&P Small Cap 600 indexes is the best approach for beginner small-cap investors, notes Georgiy Timoshin, a financial analyst at Freedom Finance Global.

Small-cap ETFs can enhance returns and diversification, but investors should be aware of the risks associated with small-cap stocks, Evens from Morningstar warns, as they “perform especially well when markets rise and when interest rates are low” but may disappoint when rates are high and markets volatile.