3 Small-Cap Stock ETFs Set to Surge if the Federal Reserve Cuts Rates

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 there's no policy change expected at the conclusion of today's two-day meeting of the Federal Open Market Committee (FOMC), investors will be poring over comments from Chair Jerome Powell and his fellow policymakers for any concrete clues about a September rate cut. 

Notably, the CME FedWatch tool, widely used to gauge rate cut expectations, now shows a 100% chance of an interest rate cut in September, with 87.7% odds of a quarter-point easing.

Rising expectations for a policy pivot are one reason why investors are starting to rotate into small-cap stocks over their larger-cap counterparts. These companies are more likely to fuel growth through floating-rate financing, and often benefit more greatly from lower borrowing costs. With small-caps generally split up into two camps - growth and value - analysts at Morgan Stanley are coming down in favor of small-cap growth in the current environment. 

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 the Small Caps that are more economically sensitive (i.e., Value) have not benefitted.”

With this in mind - and given the notoriously difficult task of picking winners in the small-cap stock space - here are the three biggest growth-oriented exchange-traded funds (ETFs) for investors looking to add small-cap exposure.

#1. Vanguard Small-Cap Growth ETF

From the Vanguard stable, the Vanguard Small-Cap Growth ETF (VBK) is designed to track the performance of the CRSP US Small Cap Growth Index. In essence, VBK provides investors with a convenient way to gain exposure to a diversified group of small-growth companies. The ETF's assets under management (AUM) currently stand at $17.8 billion.

With an average volume of about 375,000 shares, VBK is up 7.3% on a YTD basis. The fund offers a dividend yield of 0.68%, and carries an expense ratio of 0.07%.

With over 600 holdings, the top three in VBK include Targa Resources (TRGP), Deckers Outdoor (DECK) and Axon Enterprise (AXON).

#2. iShares Russell 2000 Growth ETF

Next up in our list of small-cap growth ETFs is the iShares Russell 2000 Growth ETF (IWO), from the BlackRock (BLK) group. The ETF seeks to track the investment results of an index composed of small-capitalization U.S. equities that exhibit growth characteristics - more specifically, the Russell 2000 Growth Index. IWO's AUM is currently $11.89 billion.

Shares of the IWO ETF are up about 12% on a YTD basis, and it offers a dividend yield of 0.63%. The ETF has an expense ratio of 0.23%, with an average volume of roughly 481,000 shares.

In terms of IWO's top holdings, the pole position is occupied by Insmed Inc (INSM) followed by Ftai Aviation (FTAI) and Sprouts Farmers Market (SFM). IWO has just over 1,100 holdings in total.

#3. iShares S&P Small-Cap 600 Growth ETF

We conclude our list with another ETF from the BlackRock family, with the iShares S&P Small-Cap 600 Growth ETF (IJT). The ETF seeks to track the investment results of an index composed of small-capitalization U.S. equities that exhibit growth characteristics via exposure to a group of smaller, fast-growing companies within the S&P Small-Cap 600 Index ($IQY).

With an AUM of $6.46 billion, shares of IJT have increased 12.1% in 2024 so far. The ETF also offers a dividend yield of 0.89%, with an expense ratio of 0.18% and an average volume of 
124,305 shares.

With a relatively compact 369 holdings, IJT's top three are Ensign Group (ENSG), ATI (ATI), and Mueller Industries (MLI).