Don’t Be Late to the Small-Cap Rally

Higher rates have been a headwind for small caps, which tend to be more affected by interest rate movement than large caps1.

“This is a part of the market where almost half of the universe is unprofitable2. That forces many of these companies to rely on the capital markets to fund their growth,” Scott Kefer, senior portfolio manager for VictoryShares and Solutions, told VettaFi. “With higher rates, it’s more expensive to seek that funding. We believe any relief on the rate side will make small caps that much more attractive.”

Small caps have been a challenge in terms of style exposure during the last few years, according to Kefer. However, the market has now reached a point where the performance spread between large-cap growth and small-cap value is near historic spreads.

“We think that really sets up for an attractive opportunity to invest in small caps and to lean toward small cap value,” Kefer noted.

Getting exposure through a vehicle like the VictoryShares Small Cap Free Cash Flow ETF (SFLO ) could potentially add value. SFLO is not just cheap small-cap stocks, but companies with attractive free cash flow (FCF).

SFLO tracks the Victory U.S. Small Cap Free Cash Flow Index (the Index) which provides exposure to high-quality small-cap companies trading at a discount with favorable growth prospects. The Index’s focus on companies with high FCF yields and growth rates sets it apart in the small-cap space, which includes many unprofitable names.

“We think there’s a tremendous opportunity in client portfolios to add diversification and take advantage of the very attractive absolute and relative valuations in small caps,” Kefer explained.

1/Source: Morningstar; A Fed interest-rate cut could make small-cap stocks a good investment now by Isabel Wang
2/ Based on Victory Capital Research showcasing 49% of the Russell 2000 Index has negative earnings of free cash flow as of 6/30/2024; Source: FactSet.

For more news, information, and analysis, visit the Free Cash Flow Channel

VettaFi LLC (“VettaFi”) is the index provider for SFLO, for which it receives an index licensing fee. However, SFLO is not issued, sponsored, endorsed, or sold by VettaFi, and VettaFi has no obligation or liability in connection with the issuance, administration, marketing, or trading of SFLO.

Carefully consider a fund’s investment objectives, risks, charges, and expenses before investing. To obtain a prospectus or summary prospectus containing this and other important information, visit http://www.vcm.com/prospectus. Read it carefully before investing. All investing involves risk, including the potential loss of principal.

All investing involves risk, including the potential loss of principal. Please note that the Fund is a new ETF with a limited history. The Fund has the same risks as the underlying securities traded on the exchange throughout the day. Redemptions are limited, and commissions are often charged on each trade. ETFs may trade at a premium or discount to their net asset value. The Fund invests in securities included in, or representative of securities included in, the Index, regardless of their investment merits. The performance of the Fund may diverge from that of the Index. Investments in smaller companies typically exhibit higher volatility. Investing in companies with high free cash flows could lead to underperformance when such investments are unpopular or during periods of industry disruptions.

The fund could also be affected by company-specific factors that could jeopardize the generation of free cash flow. Derivatives may not work as intended and may result in losses. Large shareholders, including other funds advised by the Adviser, may own a substantial amount of the Fund’s shares. The actions of large shareholders, including large inflows or outflows, may adversely affect other shareholders, including potentially increasing capital gains. Investments in mid-cap companies typically exhibit higher volatility. The value of your investment is also subject to geopolitical risks such as wars, terrorism, environmental disasters, and public health crises; the risk of technology malfunctions or disruptions; and the responses to such events by governments and/or individual companies.

Additional Information

Small-Capitalization Stock Risk—Investments in small-capitalization companies involve greater risks than those associated with larger, more established companies. Free Cash Flow Risk—Investing in companies with high free cash flows could lead to underperformance during periods when such investments are unpopular, and fluctuations in market conditions, industry disruptions, or company-specific factors may jeopardize the generation of free cash flow. Fund holdings and sector allocations are subject to change, may differ from the Index, and should not be considered investment advice.

The Victory U.S. Small Cap Free Cash Flow Index aims to select high quality companies from its starting universe by applying profitability screens. It then selects companies with the strongest free cash flow yield that exhibit higher growth. The Index is rebalanced and reconstituted quarterly. This Index calculates free cash flow yield by dividing expected free cash flow by enterprise value. Expected free cash flow is the average of trailing 12-month FCF and next 12-month forward free cash flow. Enterprise value (EV) measures a company’s total value, often used as a more comprehensive alternative to equity market capitalization.

The Russell 2000 Value Index is a market-capitalization-weighted index that measures the performance of those companies in the Russell 2000® Index with lower price-to-book ratios and lower forecasted growth values.

Distributed by Foreside Fund Services, LLC (Foreside). Foreside is not affiliated with Victory Capital Management Inc., the Fund’s investment adviser.

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