The Best Small-Cap ETF to Buy Right Now (and One Intriguing Alternative)

Small-cap stocks have roared back to life. After three years of lagging behind larger peers, the Russell 2000 index has surged 10.6% in November as of this writing, reflecting renewed interest in smaller companies. The benchmark S&P 500, for its part, has risen by 4.6% so far this month. For investors looking to add small-cap exposure to their portfolios, exchange-traded funds (ETFs) offer a diversified approach to this dynamic market segment.

While picking individual small-cap stocks can lead to outsized gains, it also carries significant risks. ETFs help mitigate these risks through diversification, but choosing the right fund matters. Let's analyze four top small-cap ETFs to find the best option for your portfolio.

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A cash flow champion leads the pack

The Pacer US Small Cap Cash Cows 100 ETF (NYSEMKT: CALF) focuses on small companies generating substantial free cash flow relative to their market value. The fund's strategy allows it to identify companies with the financial flexibility to invest in growth, pay dividends, or repurchase shares.

The ETF has demonstrated remarkable performance, delivering a total return (including dividends and assuming reinvestment) of 97.7% over the past five years. While its 0.59% expense ratio runs higher than its peers, and its 1.11% dividend yield appears modest, the fund's results speak for themselves.

^SPX data by YCharts.

The one drawback is that the ETF maintains a high turnover ratio of 109%, actively adjusting its holdings to maintain its focus on cash-flow generation. But for investors seeking pure small-cap exposure with a focus on financial strength, this fund stands out as the clear category leader.

A broad market contender

The Schwab U.S. Small-Cap ETF (NYSEMKT: SCHA) provides comprehensive exposure to the U.S. small-cap universe with over 1,739 holdings. The fund stands out for its rock-bottom expense ratio of 0.04% and attractive 1.33% dividend yield.

The ETF has generated a respectable 8.96% average annual return over the past five years. Its low turnover ratio of 11% helps minimize trading costs, while a strong daily trading volume of around 1.7 million shares ensures ample liquidity.

^SPX data by YCharts.

While its broad diversification offers comprehensive market exposure, the fund's passive approach of tracking the total small-cap market has delivered lower returns compared to our top performer mentioned above.

Growth with a premium

The SPDR S&P 600 Small Cap Growth ETF (NYSEMKT: SLYG) targets companies exhibiting strong growth characteristics such as accelerating earnings, robust sales growth, and high return on equity. The fund has posted a solid 9.25% average annual return over the prior five years.

^SPX data by YCharts.

The ETF's moderate 0.15% expense ratio and 53% turnover ratio reflect its growth-focused strategy. While its growth-oriented approach has merit, its modest yield of 1.12% and trading volume of under 130,000 shares per day make it less compelling than other options on this list.

An intriguing mid-cap alternative

The Vanguard Small Cap Value Index Fund (NYSEMKT: VBR) focuses on companies trading at attractive valuations based on multiple metrics. The fund has delivered a robust 79.4% total return over the past five years while offering an appealing 2.00% dividend yield.

^SPX data by YCharts.

The ETF combines Vanguard's trademark low costs with a 0.07% expense ratio and minimal turnover at 16%. With an average daily trading volume of approximately 455,000 shares, it also offers sufficient liquidity for most investors.

Notably, the fund's median market capitalization of $7.5 billion places it closer to mid-cap territory. For investors willing to venture beyond pure small-caps in exchange for higher yield and lower costs, this ETF presents a compelling alternative to our top pick.

The verdict

The Pacer US Small Cap Cash Cows 100 ETF emerges as the clear winner for investors seeking focused small-cap exposure. Despite its higher fees, the fund's emphasis on companies with strong cash flows has delivered superior returns.

However, investors prioritizing income and lower costs might find the Vanguard Small Cap Value Index Fund an attractive alternative, provided they're comfortable with its larger market cap exposure. Both funds offer distinct advantages that could benefit different investment strategies, but for pure small-cap exposure, the Pacer fund takes the crown.

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George Budwell has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.