Why Are Small-Cap ETFs Outperforming?

Mega-cap tech stocks have helped large caps dominate small-cap ETF flows and performance for years. However, this year a shift is taking place. In 2026, small-cap index ETFs are outperforming their large-cap peers as the market has broadened out.

Key Takeaways

Small-cap ETF SPSM rose 21% year to date through late July, beating the S&P 500 Index by more than 1,300 basis points.
Technology-focused PSCT’s 33% gain has been boosted by lesser-known companies.
Free cash flow ETF SFLO’s 26% weight in technology has helped it to deliver a 29% year-to-date return.

Sector Diversification Drives Small-Cap ETF Returns

To understand why small-cap ETFs are surging, investors should look under the hood. Take two low-cost core ETFs: the State Street SPDR Portfolio S&P 500 ETF (SPYM) and the State Street SPDR Portfolio S&P 600 Small Cap ETF (SPSM).

SPYM is concentrated, with information technology (IT) representing 36% of fund assets. By contrast, SPSM offers a significantly more balanced, economically

sensitive profile.

Financials lead SPSM at 19% of assets and have added value. The sector exposure is closely followed by industrials at 18%. Meanwhile, technology makes up just 12% of the small-cap ETF’s assets. When market rallies broaden into cyclical corners of the economy, SPSM’s heavier tilts toward banks, construction, and machinery companies offer a tailwind.

Despite its strong performance, many investors have not recently turned to SPSM. The ETF gathered just over $1 billion this year. This is miniscule compared to SPYM’s $52 billion cash haul.

Core & Cash Flow ETF Comparison

Small-Cap Tech Outpaces Mega-Cap Giants

Even within the tech sector, small caps are having an impressive year. The Invesco S&P SmallCap Information Technology ETF (PSCT) is up an impressive 37% year to date, comfortably outstripping the Technology Select Sector SPDR Fund (XLK) and its 19% return.

XLK relies heavily on mega caps like Microsoft (MSFT) and NVIDIA (NVDA). However, PSCT’s rally has been powered by lesser-known companies such as electronic manufacturing services provider Plexus (PLXS) and satellite communications specialist ViaSat (VSAT). Yet, PSCT manages nearly $500 million in assets, significantly less than $115 billion in XLK.

Free Cash Flow Factor ETFs Performing Well

The small-cap outperformance trend extends into factor-based strategies as well. The VictoryShares Small Cap Free Cash Flow ETF (SFLO) is up 29% year-to-date, modestly outpacing its large-cap counterpart, the VictoryShares Free Cash Flow ETF (VFLO), which has posted a still-healthy 28% gain.

While VFLO maintains a hefty 23% allocation to information technology, SFLO leans in even further with a 26% exposure to technology. Strong performers within SFLO’s tech sleeve this year include Extreme Networks, RingCentral, and Penguin Solutions.

By focusing on high-quality cash flow generators, SFLO highlights how rules-based factor discipline can uncover hidden strength. SFLO will turn three years old at the end of 2026. However, with $650 million of assets, it is less known than the $9 billion VFLO.

Analyzing What is Under the Hood of Small-Cap ETFs

Investors looking to diversify beyond mega-cap concentration risk would do well to inspect what’s under the hood. As market breadth expands, small-cap index ETFs are proving they belong as part of the asset allocation discussion. But it pays to look inside an ETF.

For more news, information, and analysis visit the Thematic Investing Content Hub.

VettaFi LLC (“VettaFi”) is the index provider for SFLO and VFLO, for which it receives an index licensing fee. However, SFLO and VFLO are not issued, sponsored, endorsed, or sold by VettaFi, and VettaFi has no obligation or liability in connection with the issuance, administration, marketing, or trading of SFLO and VFLO.

Originally posted on ETF Trends

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