AVUV ETF: The Right Approach to Investing in Small Cap Stocks

Investors are giving small-cap stocks a fresh look this summer as hot large-cap tech stocks cool off. For example, the Invesco QQQ Trust (QQQ), which invests in the tech-heavy NASDAQ 100 (NDX), is down 12.2% over the past month, while the small-cap stocks of the Russell 2000 have held their own.

The Avantis U.S. Small Cap Equity ETF (AVUV) is a good way to invest in these stocks. 

I’m bullish on this $12.9 billion ETF from American Century’s Avantis because it effectively invests in small-cap value stocks, combining elements of index investing and active management. I’m also constructive on AVUV based on its excellent performance in recent years, which we’ll discuss in detail below. Wall Street analysts also believe the ETF could have considerable potential upside ahead.

What is the AVUV ETF’s Strategy? 

According to Avantis, AVUV “Invests in a broad set of U.S. small-cap companies and is designed to increase expected returns by focusing on firms trading at what we believe are low valuations with higher profitability ratios.”

The fund seeks to combine the advantages of index investing with those of active portfolio management. Avantis explains that AVUV “pursues the benefits associated with indexing (diversification, low turnover, transparency of exposures), but with the ability to add value by making investment decisions using information in current prices.”

This approach is a very sensible one when investing in small-cap stocks. While the Russell 2000, an index of U.S. small-caps, was hot in July, gaining 10% for the month, simply investing in this index has its pitfalls as the Russell 2000 contains the stocks of many unprofitable companies that will never be profitable and plenty of “zombie companies.”

It’s important to remember that while the universe of small-cap stocks contains plenty of hidden gems, many of these stocks are “small” in terms of market cap for a reason; they’re just not great companies. 

By investing in a large number of small-cap stocks (to capture the benefit of diversification) but focusing on value and using active management to weed out many of these long-term losers and zombie companies, AVUV is able to create a much more competitive, streamlined portfolio of small-cap stocks while still enjoying some of the benefits of index investing. 

As we’ll see below, AVUV’s quietly outstanding performance in recent years shows the merits of this strategy. 

Beating the Competition 

When it comes to performance, AVUV has handily beaten its benchmark, the Russell 2000 Value Index, over the past three years, illustrating the value of bringing elements of active management and stock picking to the small-cap universe. 

As of the end of July, AVUV has generated an exceptional three-year annualized return of 12.7%, thrashing the Russell 2000 Value Index’s comparatively lackluster return of 4.6%.  

Moreover, AVUV has beaten the broader Russell 2000 Index to an even greater degree; the Russell 2000 has returned just a measly 1.9% (as of July 31) on an annualized basis over the past three years, including its strong performance in July. However, we should see how AVUV stack up against the big boys of the broader market; As it turns out, it more than holds its own. 

Believe it or not, AVUV even surpasses the S&P 500 (SPX), which is rightfully revered for its strong returns over the years. With a three-year annualized return of 12.7%, AVUV has beaten S&P 500 ETFs like the Vanguard S&P 500 ETF (VOO), which generated a 9.5% annualized three-year return as of July 31. 

Therefore, AVUV has been an outstanding performer over the past three years, whether evaluated against its small-cap value benchmark or even the mighty S&P 500. It gives credence to the fund’s strategy of bringing some active management to small-cap index investing.

It should be noted that the fund is still relatively new, so while this three-year outperformance is quite impressive, it remains to be seen whether it will continue to outperform the small-cap indices (as well as the S&P 500) over a longer time frame. So far, it looks extremely promising. 

It’s also encouraging that AVUV has outperformed the S&P 500 without owning the large-cap tech stocks that have driven many of the S&P 500’s gains in recent years. AVUV has just a 5% weighting towards technology, while the S&P 500 still holds well over 30% of tech firms, even after the recent tech sell-off. 

Of course, there’s nothing wrong with owning these long-term winners, but many of these stocks have high valuations, even after this summer’s sell-off. This means that the types of stocks AVUV holds could offer investors more downside protection and more upside as they haven’t run up as much as these large-cap tech stocks over the last year and a half. 

Diversified Portfolio 

AVUV is quite diversified; it holds 733 stocks, and its top 10 holdings account for just a miniscule 8.2% of the fund’s assets. 

You can check out an overview of AVUV’s top 10 holdings below. 

As you can see, none of the fund’s holdings feature a weighting of more than 0.9%, making this an extremely diversified fund with very little concentration risk. 

AVUV Is a Dividend Payer

Before I conclude this piece, I would like to mention two additional factors; the first one is AVUV being a dividend payer. Although it’s not a main reason to invest in this ETF, AVUV is currently yielding 1.7% yearly dividends. While this yield isn’t particularly noteworthy, it is higher than the average yield of the S&P 500 and contributes to investors’ total returns over time. 

The second factor is its very reasonable charging fees with expense ratio of 0.25%. This means an investor in the fund will pay just $25 in fees on a $10,000 investment annually. 

Is AVUV Stock a Buy, According to Analysts?

Turning to Wall Street, AVUV earns a Hold consensus rating based on 372 Buys, 339 Holds, and 23 Sell ratings assigned in the past three months. The average AVUV stock price target of $107.57 implies 20.9% upside potential from current levels.

A Sound Approach  

Not only has AVUV outperformed its benchmark, it has outperformed small-cap stocks more broadly and even handily beaten the S&P 500 over the past three years, despite the fact that it doesn’t own the large-cap tech stocks that have driven considerable gains for the S&P 500. 

I’m bullish on AVUV based on this outperformance, and believe its actively-managed, diversified portfolio of carefully-selected small cap value stocks makes it well-positioned for the uncertain market environment investors are currently navigating through. Further positives include the fact that it pays a dividend, charges a reasonable fee, and is viewed favorably by sell-side analysts.

Disclosure