Why now is a good time to turn to small-cap ASX ETFs

A recent report from VanEck shows there is potential for strong growth amongst small-cap companies. 

Traditionally, small-cap stocks have a market capitalisation ranging from a few hundred million to $2 billion.

The upside can be greater for these companies that still are largely unproven or are perhaps yet to generate profit.

But they also tend to be more volatile than larger-cap stocks.

The dust settles after earnings season

The report from VanEck shows the market reaction to earnings season was more intense than in years gone by. 

According to the ETF provider, most companies (62%) reported in-line results, with 22% delivering beats and slightly outpacing misses (16%).

However, VanEck suggests market reactions did not reflect this 'solid' result. 

One in five reporting companies moved more than 10% after they announced their results. 

Analysing the results on a market-weighted basis, mid-cap companies, as represented by the S&P/ASX MidCap 50 Index, led earnings beats this season, with a net-beat rate of 2.9% versus the S&P/ASX 200 Index's 1.15%.

Small caps battered but not beaten

VanEck also said that small caps, as represented by the companies in the S&P/ASX Small Ordinaries Index (ASX: XSO), performed the worst from an earnings per share (EPS) surprise perspective.

What is interesting is that after the earnings season, an analysis of the consensus 12-month price targets shows that small caps sit highest.

The outlook for small companies is brighter. The RBA is starting to cut rates, lowering capital costs. The economic outlook has led to small companies having the highest price-target revisions, signalling the market's conviction in Australian small caps.

VanEck said that historically, during this type of cycle, small caps have offered more upside than large caps because they have fallen further or not kept pace with large caps as GDP growth slowed. 

Importantly, the provider did also reinforce that the Small Ords has delivered lower cumulative returns relative to the broader, large-cap dominated S&P/ASX 200 Index (ASX: XJO) over the long term.

This reflects the volatility that may come with this investment class compared to blue-chip stocks.

How do investors gain exposure?

Based on the research from VanEck, investors who have been eyeing specific small caps may be well-positioned to buy the dip, with economic tailwinds potentially coming in the short term. 

Alternatively, there are ASX ETFs that offer more diversified exposure to the small-cap sector. 

For example, the VanEck Vectors Small Companies Masters ETF (ASX: MVS). 

It tracks an index consisting of 60 small-cap ASX-listed companies domiciled in Australia or New Zealand with strong growth characteristics and sound fundamental indicators of quality.

It has a very evenly distributed portfolio, with its largest exposure representing just 2.7% of the fund. 

The fund has risen more than 17% YTD. 

Other ASX ETFs tracking small-caps include: 

• SPDR S&P/ASX Small Ordinaries Fund (ASX: SSO) – Tracks the returns of the Small Ordinaries Index, which are companies included in the S&P/ASX 300 Index (ASX: XKO), but not in the S&P/ASX 100 Index (ASX: XTO).
• iShares S&P/ASX Small Ordinaries ETF (ASX: ISO) – Also measures the performance of small-capitalisation Australian equities included in the ASX 300 Index, but not in the ASX 100 Index.
• Vanguard MSCI Australian Small Companies Index ETF (ASX: VSO).