Investing in the right publicly-listed small-cap companies has the potential to be very profitable for you. Unfortunately, investing in a poor opportunity could end up with you losing your money.
Fortunately, Exchange-Traded Funds (ETFs) are investment vehicles that invest in baskets of securities and simplify the aspect of spreading your capital across a diverse group of equity securities and other asset classes trading on stock markets.
Finding high-quality small-cap stocks requires extensive research, and you need to constantly monitor your portfolio and readjust your holdings to align your portfolio with profitability. It can all get overwhelming for new investors or even seasoned investors who don’t have the time to put in all that effort.
My guide to the best small-cap ETFs in Canada will provide you with a list of investment vehicles that could allow you to gain hands-off exposure to baskets of small-cap stocks.
You can pick some of these diamonds in the rough without putting in too much effort in creating and managing a portfolio yourself through these small-cap funds.
Small-cap publicly-traded companies are some of the newest companies trading on stock exchanges and are characterized by a market capitalization between $250 million and $3 billion.
Companies with smaller market capitalization are considered microcaps, and large-cap companies are entities with an over $10 billion market cap.
Small-cap ETFs are investment vehicles that provide you with exposure to a basket of securities that track the performance of small market capitalization companies listed on stock exchanges.
When you invest in a small-cap fund, the fund manager allocates your investment capital to a group of different publicly-listed small-cap companies.
Not all small-cap ETFs take the same approach to provide investors with exposure to these companies. Some fund managers follow different market indices and allocate resources to holdings based on the weighting as in the underlying indices.
Other fund managers tweak the holdings in some funds to try and outperform the underlying indices.
The difference in approaches by different fund managers means that the performances for all small-cap ETFs will not be the same. Some might be more expensive than others or underperform based on the fund managers’ objectives.
It is crucial to pick the right small-cap ETFs that align with your risk tolerance and long-term financial goals.
Considering that ETFs were created in Canada, it’s surprising that the TSX does not boast many small-cap ETFs. In fact, there is only one TSX-listed small-cap ETF that you can consider.
However, you can find several US-listed small-cap funds that you can consider investing in to meet your long-term financial goals.
Here are the qualities that are common among the best small-cap ETFs that I have considered to narrow down my list of the top ETFs available to Canadians on this guide:
- A low expense ratio
- A significant amount of liquidity
- Diversification from major market indices
This section of my guide to the best small-cap ETFs in Canada will list down the only TSX-listed fund and the different US-listed small-cap ETFs that are the most suitable based on the criteria I have described above.
1. iShares S&P/TSX Small-Cap Index ETF (XCS)
Some key facts about iShares S&P/TSX Small-Cap Index ETF (XCS) as of November 17, 2021:
- Ticker: TSX:XCS
- Inception Date: May 14, 2007
- Assets Under Management: $179.24 million
- Expense Ratio: 0.59%
iShares S&P/TSX Small-Cap Index ETF (XCS) is the only Canada-listed small-cap ETF. The fund is managed by BlackRock, and it seeks to provide you with long-term capital growth by emulating the performance of the S&P/TSX SmallCap Index to the best of its ability and before expenses.
iShares XCS ETF is one of the costliest small-cap ETFs on this list, and it allocates its entire assets to 235 small-cap Canadian equity securities.
The portfolio can be used to diversify a portfolio of large or mid-cap Canadian equities with exposure to small-cap Canadian equity securities, and it could be used to express a view on small-cap Canadian stocks.
2. Vanguard Small-Cap Value ETF (VBR)
Some key facts about Vanguard Small-Cap Value ETF (VBR) as of November 17, 2021:
- Ticker: NYSE Arca:VBR
- Inception Date: January 26, 2004
- Assets Under Management: US$27.27 billion
- Expense Ratio: 0.07%
Vanguard Small-Cap Value ETF (VBR) is a US-listed small-cap ETF managed by Vanguard. Vanguard VBR ETF seeks to provide you with long-term capital growth by replicating the performance of the CRSP US Small Cap Value Index, net of expenses. The underlying index measures the returns of small-cap value stocks.
Vanguard VBR ETF offers you very low-cost exposure to a diversified basket of small-cap equity securities. The fund manager takes a passively-managed approach with VBR ETF, allowing it to keep its expense ratio significantly low.
3. iShares Core S&P Small-Cap ETF (IJR)
Some key facts about iShares Core S&P Small-Cap ETF (IJR) as of November 17, 2021:
- Ticker: NYSE Arca:IJR
- Inception Date: May 22, 2000
- Assets Under Management: US$76.04 billion
- Expense Ratio: 0.06%
iShares Core S&P Small-Cap ETF (IJR) is one of the least expensive entries on my list of the best small-cap ETFs in Canada. The fund is managed by BlackRock, and it seeks to provide you with long-term wealth growth by tracking the investment results of an index composed of small-cap US-listed equity securities.
iShares IJR could be used as a core holding for investors seeking long-term growth through capital appreciation. It offers you exposure to small-cap US stocks and takes a low-cost and tax-efficient approach that allows it to boast an expense ratio of just 0.06%.
4. Vanguard FTSE All-World ex-US Small-Cap ETF (VSS)
Some key facts about Vanguard FTSE All-World ex-US Small-Cap ETF (VSS) as of November 17, 2021:
- Ticker: NYSE Arca:VSS
- Inception Date: April 2, 2009
- Assets Under Management: US$10.05 billion
- Expense Ratio: 0.11%
Vanguard FTSE All-World ex-US Small-Cap ETF (VSS) is a fund managed by Vanguard, and it seeks to provide you with wealth growth by replicating the performance of the FTSE Global Small Cap ex US Index, to the best of its ability and net of expenses.
Vanguard VSS ETF offers you the opportunity to gain diversified exposure to international equity securities outside the US in developed and emerging markets worldwide.
The fund manager uses a passively managed index sampling approach to manage Vanguard VSS ETF. It is a low-cost fund that boasts an expense ratio of just 0.11%.
5. State Street SPDR S&P 600 Small-Cap Growth ETF (SLYG)
Some key facts about State Street SPDR S&P 600 Small-Cap Growth ETF (SLYG) as of November 17, 2021:
- Ticker: NYSE Arca:SLYG
- Inception Date: September 25, 2000
- Assets Under Management: US$2.51 billion
- Expense Ratio: 0.15%
State Street SPDR S&P 600 Small-Cap Growth ETF (SLYG) is a fund managed by State Street Global Advisors, and it seeks to provide you with significant wealth growth by tracking the investment results of the S&P SmallCap 600 Growth Index, before fees and expenses.
The fund manager readjusts the portfolio to include equity securities that show the strongest growth characteristics based on sales growth, earnings change to price, and momentum.
State Street SLYG ETF has an expense ratio of 0.15%, making it slightly expensive than many of the other funds listed on my guide to the best small-cap ETFs in Canada.
6. iShares Russell 2000 ETF (IWM)
Some key facts about iShares Russell 2000 ETF (IWM) as of November 17, 2021:
- Ticker: NYSE Arca:IWM
- Inception Date: May 22, 2000
- Assets Under Management: US$73.86 million
- Expense Ratio: 0.19%
iShares Russell 2000 ETF (IWM) is another small-cap fund managed by BlackRock. iShares IWM seeks to provide you with investment returns by tracking the investment results of the Russel 2000 Index that is composed of small-cap US-listed equity securities.
Investing in iShares IWM means your capital is spread across 2000 small-cap stocks, providing you with substantial diversification for long-term growth and relatively reduced capital risk. The fund comes with an expense ratio of 0.19%.
7. WisdomTree US SmallCap Dividend Fund (DES)
Some key facts about WisdomTree US SmallCap Dividend Fund (DES) as of November 17, 2021:
- Ticker: NYSE Arca:DES
- Inception Date: June 16, 2006
- Assets Under Management: US$1.94 million
- Expense Ratio: 0.38%
WisdomTree US SmallCap Dividend Fund (DES) is a small-cap ETF managed by WisdomTree, and it seeks to provide you with investment returns by tracking the investment results of dividend-paying small-cap equity securities trading in US stock markets.
The fund takes a different approach than most of the others on the list that focuses entirely on capital appreciation to provide you with returns on your investment.
WisdomTree DES ETF is a more expensive fund to own because it comes with an expense ratio of 0.38%. However, the additional expense could be worth it because WisdomTree DES ETF offers you wealth growth through capital appreciation and shareholder dividends at a 1.80% dividend yield.
8. iShares MSCI EAFE Small-Cap ETF (SCZ)
Some key facts about iShares MSCI EAFE Small-Cap ETF (SCZ) as of November 17, 2021:
- Ticker: NASDAQ:SCZ
- Inception Date: December 10, 2007
- Assets Under Management: US$15.50 billion
- Expense Ratio: 0.40%
iShares MSCI EAFE Small-Cap ETF (SCZ) is another US-listed small-cap fund managed by BlackRock. iShares SCZ ETF seeks to provide you with investment returns by tracking the investment results of internationally diversified small-cap equity securities trading in Europe, Australia, Asia, and the Far East markets.
You can use iShares SCZ ETF to diversify your portfolio through exposure to internationally diversified equity securities in various developed international stock markets. The fund comes with an expense ratio of 0.40%.
This section of my guide to the best small-cap ETFs in Canada will cover the advantages and disadvantages of investing in these financial instruments for your portfolio.
Understanding the pros and cons of small-cap ETFs in Canada might help you make more well-informed investment decisions about whether these assets align with your financial goals and risk tolerance levels.
- Greater growth potential: Small-cap companies are often new companies that offer exciting ideas and have plenty of room to grow, offering the opportunity for stellar shareholder returns through capital appreciation. Large-cap companies are well-established entities that are unlikely to provide similar capital appreciation.
- Diversification: ETFs offer you a relatively reduced degree of capital risk compared to investing in individual small-cap companies. Investing in small-cap ETFs when you already have exposure to large-cap stock in your portfolio also opens up the ability to provide you with more capital growth.
- Hidden opportunities: Many analysts and the general public tend to ignore small-cap companies due to their valuations, allowing many diamonds in the rough to be unnoticed. Investing in small-cap ETFs offers you the opportunity to invest in these small-cap companies that you might otherwise ignore.
- Flexibility: Small-cap companies are far more flexible and open to change than their larger counterparts. The flexibility allows these companies to recover from missteps rapidly or enact a change in direction without the resistance that well-established companies might face.
- Possibility of fraud: The lack of coverage from many analysts and financial media can ignore diamonds in the rough, but there are also small-cap companies susceptible to pump-and-dump schemes. It is possible to gain exposure to such companies by investing in small-cap ETFs in Canada.
- Greater volatility: Small-cap publicly-traded companies are more prone to volatile market environments. Small-cap companies with great potential can beat well-established companies in terms of providing you with returns in the long run, but the short-term volatility might be too much for risk-averse investors.
- Prone to economic changes: Small-cap publicly-traded companies don’t boast the wide economic moats that large-cap companies do. It means that these companies do not have a margin for safety. The lack of cash reserves, slow business cycles, or significant downturns in the broader market can devastate small-cap stocks.
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Small-cap ETFs undoubtedly entail more significant capital risk in the short term compared to large-cap ETFs. However, history has shown that investors who have the stomach to bear the short-term volatility can be rewarded with stellar shareholder returns in the long run.
If you are new to investing and you want to go with an aggressively-tilted portfolio, the right small-cap ETFs can be an excellent starting point for you to consider, provided that you understand the risk and reward with this type of strategy before you decide to invest in baskets of these relatively obscure companies.
The world of ETF investing expands far beyond small-cap ETFs. The energy sector has been booming in recent months and has historically been an excellent long-term performer. Check out my guide to the best energy ETFs in Canada if you are interested in funds that focus on the booming energy industry.