Why Avantis US Small Cap Value ETF’s Stellar Returns Could Continue

Key Morningstar Metrics for Avantis US Small Cap Value ETF

• Morningstar Medalist Rating: Silver
• Process Pillar: Above Average
• People Pillar: Above Average
• Parent Pillar: Average

Avantis US Small Cap Value ETF AVUV should continue to thrive because it diversifies well and balances sound quality and value exposure.

This fund hunts the small-cap universe for stocks that are cheap and profitable, an attractive duo of factors. Both have historically been tied to market-beating returns (especially in the small-cap market), and they tend to excel at different times. Balancing the two should keep the fund competitive in most market environments.

This fund starts with stocks’ market-cap weightings and tilts toward those with the strongest value and profitability traits. This approach enhances factor exposure while incorporating the information stored in stock prices. The portfolio trades at cheaper valuations than the Russell 2000 Value Index (the small-value Morningstar Category benchmark). It also bested 85% of its peers in return on invested capital, a profitability measure.

Using market-cap weighting as a foundation helps stymie turnover, and Avantis’ disciplined trading approach helps the same cause. The implementation team constantly weighs trading costs against the expected added value of the move, acting only when the scales tip in its favor. This flexibility is an advantage over broad index funds that mirror their benchmarks’ every move.

A unique sector composition induces some risk. Avantis US Small Cap Value ETF avoids regulated utilities and real estate securities and takes a small stake in healthcare stocks. Energy and consumer discretionary companies fill the void. Those sector portfolio weightings normally exceed the Russell 2000 Value Index’s by 5-10 percentage points apiece. Favoring cyclical sectors to defensive ones has worked wonders since this fund debuted, but that volatility may not be rewarded long term.

Avantis US Small Cap Value ETF: Performance Highlights

This fund has dominated since hitting the market in September 2019. The exchange-traded fund gained 17.1% annualized from that point through July 2024, crushing the Russell 2000 Value Index’s 10% yearly return and ranking in the top decile of small-value peers. It charted a more volatile course along the way, but the fund’s risk-adjusted performance still measures up wonderfully to its category benchmark and rivals.

This fund is at its best when the value and quality factors generate strong payoffs. At least one of the two has routinely delivered. Firms like Commercial Metals CMC and student loan servicer Navient NAVI—holdings since 2019 for their value and quality traits—helped the ETF rank in the top 20% of the small-value peer group in each calendar year from 2021 through 2023. Factor payoffs are cyclical, and the two this fund pursues won’t always thrive, but it should fare well when at least one is in vogue.

The fund’s sector bets can influence category-relative performance, too. Its relatively heavy energy stake was a boon in 2022 when the sector held up far better than the rest of the market, but that weighed on returns in the first half of 2024. The fund’s procyclical sector composition has worked to its advantage, but there’s no guarantee it will continue in the long run.

Bending toward energy and consumer discretionary and away from utilities and healthcare leads to a somewhat bumpy ride. It’s prone to deeper drawdowns than most when its sector biases work against it. That played out in the early-2020 pandemic-fueled drawdown, when the ETF slid about 3.5 percentage points further than the Russell 2000 Value Index. Even if Avantis US Small Cap Value ETF’s superb performance continues, some gut-checks will likely come with it.