The Disparity & Opportunity in Small-Cap ETFs

It’s true that it’s been a challenging year for U.S. small-cap ETFs. Using the iShares Russell 2000 ETF (IWM A-) as a benchmark for the category, we immediately see that 2025 has been marked by red ink. IWM remains down year-to-date even as large-caps flirt with record highs.   

But two other things that are equally true. 

First, the tide may be turning. Small-cap equity ETFs have staged a bit of a turnaround in the second quarter. And more specifically, in the past month, they’ve delivered positive upside. IWM is up more than 3% in a month. The rally has been a broad-based U.S. equity rebound, but still, small-caps are trying to keep up.   

Secondly, and more importantly, dispersion in performance among small-cap names is wide. From a regional perspective, international ex-U.S. small-caps are having a downright good year. The MSCI World ex-USA Small Cap Index is up 18.2% YTD, according to MSCI data. Strategies focusing on value and quality are also doing well. 

All of that is to say, in the words of Phill McInnis, chief investment strategist at Avantis Investors: “In small-caps, you need to be selective.”

The macro uncertainty and policy noise that has weighed on small-cap stocks this year haven’t really disappeared. Economic data remains mixed. Skies remain largely cloudy from that perspective. 

That said, there are potential tailwinds for the category ahead. Domestically, legislation such as the “Big Beautiful Bill,” bank lending rules and possibly lower interest rates could potentially support equities in general, and small-caps especially, if domestic economic growth picks up pace. 

There’s also valuation. U.S. small-cap stocks are trading at nearly a 55% discount to large-caps, as measured by the price-to-earnings ratios of the Russell 2000 vs. Russell 1000. Price-to-book shows a similar deep discount. And in a year when foreign equities have outperformed U.S. peers, it turns out the valuation gap internationally, too, is historically wide.   

It’s no surprise that a look at the best-performing small-cap ETFs year-to-date are a lineup of international ex-U.S. funds. The iShares MSCI Europe Small-Cap ETF (IEUS A-) and WisdomTree Europe SmallCap Dividend Fund (DFE B+) are each up about 22%, for example. Brazilian small-caps are on fire.  

Also among top 10 best performers are funds focused specifically on the valuation opportunity, such as the Avantis International Small Cap Value ETF (AVDV ) and the Dimensional International Small Cap Value ETF (DISV B+), each up about 21% this year. For comparison, IWM is down more than 3% in the same time frame. 

“Small-caps globally have been an interesting opportunity this year, where we’ve seen strong results,” McInnis said. “We have to give a nod to the (weaker) dollar effect, which has been a big tailwind across the board for international equity markets. But valuations and fundamentals have mattered.” 

As he puts it, in the small-cap space, being thoughtful about selection criteria has been key to managing the wide dispersion in stock performance. Value has done well. Valuations are indeed key, and not merely an exercise in mapping price multiples to book value. It’s about capturing profitability — the small-cap companies that are attractively valued but that are also fundamentally strong, profitable.

As an example, AVDV is built around that investment thesis, much like its U.S. counterpart, the Avantis U.S. Small Cap Value ETF (AVUV ). But internationally, the selection effort considers not only a company’s balance sheet but also the balance sheet of the broader country they reside in, according to McInnis. 

As we head into the second half of the year, uncertainty is still a prevailing theme for markets and for small-caps. Skies remain cloudy. But the key takeaway from the category performance so far in 2025 is twofold. Don’t be afraid to swim in international waters in search of positive returns. More importantly, in the words of McInnis, remember: “In small-caps, you need to be selective.”  

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