7 Best Small-Cap Funds to Buy and Hold

Debbie Carlson

Small-cap funds contain equity securities of smaller companies.

Investments focusing on small-cap companies may perform well as the Federal Reserve keeps interest rates low. Robert Johnson, a professor of finance at Creighton University, says that small caps returned 28.4% annualized and large caps returned 14.4% when the Fed is not raising interest rates. Many small-cap investments lagged large caps in the current market cycle, which could mean these investments are a better value, especially for people with a long-term view in mind. Here are seven small-cap investments to buy and hold.

ProShares Russell 2000 Dividend Growers ETF (ticker: SMDV)

One of the small cap exchange-traded funds favored by Chuck Self, chief investment officer at iSectors, is SMDV. The ETF consists of companies in the Russell 2000 that have increased dividend payouts for at least 10 consecutive years. The ETF uses equal weighting to increase diversification in the portfolio. SMDV holds high-quality companies that historically have captured more of the market gains and less of the losses. "This allows investors to buy and hold this fund through the ups and downs of the market," he says. The fund has a bias toward financial and utility stocks, which make up nearly half of the holdings. It's up 16% in 2019.

Invesco S&P SmallCap Energy ETF (PSCE)

PSCE follows the S&P Small-Cap 600 Capped Energy Index, a market-cap-weighted index of energy stocks. Steven Jon Kaplan, CEO at True Contrarian Investments, has two reasons why he likes this ETF as a small-cap stock to buy and hold now. "Small-cap shares overall are out of favor while energy shares are even more glaringly disliked and undervalued, making this a rare double play on two unpopular themes," he says for investors looking for bargains. The fund has a tilt toward companies in the exploration, production, services and equipment side of the energy sector. "Corporate energy insiders have been especially heavily buying their own shares in recent months which is a sure sign that a substantial rebound is likely during the coming year," he says.

WisdomTree Emerging Markets Small-Cap ETF (DGS)

Many investors are underweight international small-cap stocks, especially in emerging markets. DGS follows the WisdomTree Emerging Markets SmallCap Dividend Index and is another one of Self's favorite small-cap ETFs. It consists of the bottom 10% in market capitalization of emerging market companies that pay dividends. The fund's constituents are weighed by dividends, so the higher the dividends paid, the more weight a company has in the fund. Doing so reduces portfolio volatility while focusing returns on securities that have the best potential prospects. "For investors wishing to participate in emerging markets in a relatively conservative manner, this fund is an excellent way to do so," Self says. Taiwan and Hong Kong are the two regions with the biggest weighting in the fund. Year-to-date, it's up 15%.

Vanguard Small-Cap Index (NAESX)

NAESX follows the CRSP U.S. Small Cap Index, a broadly diversified index of stocks of small U.S. companies. "I am bullish on this fund because of the current expansive monetary policy environment and prospects for that environment to continue," Johnson says. The mutual fund holds a balanced mix of cyclical, defensive and economically sensitive stocks. "With the Fed unlikely to raise interest rates in the near future, small caps may well flourish and getting broad exposure at minimal cost is a winning strategy," he says. The fund carries an expense ratio of 0.17%, or $17 for every $10,000 invested annually. NAESX has beaten its peers and the small blend category for the past 15 years.

VanEck Vectors Junior Gold Miners ETF (GDXJ)

This ETF is a fund of small- and some mid-cap gold mining and silver mining companies. Since January 2016, this fund charged ahead and more than doubled in value, Kaplan says. GDXJ remains well below its April 2011 top and still represents an attractive buy for the long-term investors. "It will likely perform well whenever investors are disenchanted with U.S. government policies and especially when investors are looking for alternatives to the usual U.S. equity index funds," he says. Canadian companies represent 54% of the fund, with Australia at 20%. The fund boasts a 30% year-to-date return.

First Trust Dow Jones Select MicroCap Index Fund (FDM)

Small-cap companies usually hold market capitalization between $300 million and $2 billion. FDM looks for U.S. companies in the smaller end of this range. It follows DJ Select Micro-Cap Index, which includes companies in the bottom two market-cap deciles. Self says companies are screened for liquidity and value measures such as the price-earnings ratio, price-sales ratio and recent increases in profitability. "These filtered companies have the ability to grow fast given their small size and yet have the financial stability to sustain themselves through any rough times," he says, adding that "small allocations to this fund may add diversification to U.S. equity portfolios."

VanEck Vectors India Small-Cap Index ETF (SCIF)

Investors who want to invest in an emerging market powerhouse that isn't China can look to India. Kaplan's choice: SCIF. The fund follows the MVIS India Small-Cap Index. Kaplan says the fund is down significantly from its high set in 2018, which makes it undervalued and a cheap buy for an investor with a long-term view. Investors are disenchanted by the policies of Indian Prime Minister Narendra Modi along with tensions with their neighbor Pakistan, which contribute to the fund's undervaluation, he says. Investors willing to take on some risk in an emerging market small-cap ETF could be rewarded in the long term, he says. The fund is pricier than the average ETF at 0.83%, but it also offers access to a harder-to-reach asset class.

The best small-cap funds for long-term investors.

-- ProShares Russell 2000 Dividend Growers ETF (SMDV)

-- Invesco S&P SmallCap Energy ETF (PSCE)

-- WisdomTree Emerging Markets Small-Cap ETF (DGS)

-- Vanguard Small-Cap Index (NAESX)

-- VanEck Vectors Junior Gold Miners ETF (GDXJ)

-- First Trust Dow Jones Select MicroCap Index Fund (FDM)

-- VanEck Vectors India Small-Cap Index ETF (SCIF)

Debbie Carlson has more than 20 years experience as a journalist and has had bylines in Barron's, The Wall Street Journal, the Chicago Tribune, The Guardian, and other publications. Follow her on Twitter at @debbiecarlson1.