Free Cash Flow Can Help Navigate the Small-Cap Profitability Problem

During VettaFi’s recent 2026 Market Outlook Symposium, Lance Humphrey, head of portfolio management for VictoryShares and Solutions, highlighted this statistic that might give an investor pause. When nearly 40% of an index consists of companies losing money, buying an ETF tracking a broad small-cap benchmark can mean taking on potentially unwarranted risk.

VictoryShares and Solutions believe investment approaches that use free cash flow (FCF) as a metric for constituent selection may help investors access small-cap growth without exposing themselves to unprofitable companies at this level.

Unlike earnings, which can be susceptible to manipulation through accounting maneuvers, FCF represents the actual cash a company generates after accounting for capital expenditures. It is a direct measure of financial health that VictoryShares and Solutions believe is a more effective way to assess a company’s quality. The VictoryShares Small Cap Free Cash Flow ETF (SFLO ) tracks an index that uses FCF at the core of its methodology.

“SFLO’s Index avoids those unprofitable companies by seeking profitability and free cash flow,” Humphrey said. By using a methodology that screens specifically for high FCF, ETFs like SFLO naturally filter out the unprofitable segment of the market.

As investors navigate a challenging market environment marked by mixed economic signals, including persistent inflation and a potentially softening labor market, quality becomes paramount. Companies with demonstrable financial strength, as shown through positive cash generation, manageable debt, and consistent historical profitability, become the more important choice. In a risk-on rally, junk stocks might fly, but over the long term, and specifically in uncertain macro environments, this approach is based on the belief that fundamentals matter.

VictoryShares and Solutions believe that by targeting small-cap companies that are generating FCF today, this approach seeks exposure to higher-quality segments of the market while limiting exposure to more speculative, unprofitable areas of the Russell 2000 Index.

1/ Source: FactSet as of 12/31/2025; Universe utilized is the Russell 2000® Index (excluding Financials and Real Estate). Unprofitable companies are determined by those that have either negative earnings or negative free cash flow.

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VettaFi LLC (“VettaFi”) is the index provider for SFLO, for which it receives an index licensing fee. However, SFLO is 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.

Disclosure Information

Carefully consider a fund’s investment objectives, risks, charges, and expenses before investing. To obtain a prospectus or summary prospectus containing this and other important information, visit http://www.vcm.com/prospectus. Read it carefully before investing.

All investing involves risk, including the potential loss of principal.  The market prices of securities may go up or down, sometimes rapidly or unpredictably, due to general market conditions, such as real or perceived adverse economic, political, or regulatory conditions, recessions, inflation, or changes in interest or currency rates. The Fund has the same risks as the underlying securities traded on the exchange throughout the day. ETFs may trade at a premium or discount to their net asset value. Investing in companies with high free cash flows could lead to underperformance when such investments are unpopular or during periods of industry disruptions. The fund could also be affected by company-specific factors that could jeopardize the generation of free cash flow. Investments in smaller companies typically exhibit higher volatility. Index Funds invest in securities included in, or representative of securities included in, the Index, regardless of their investment merits. The performance of the Fund may diverge from that of the Index.  Large shareholders, including other funds advised by the Adviser, may own a substantial amount of the Fund’s shares. The actions of large shareholders, including large inflows or outflows of cash, may adversely affect other shareholders, including potentially increasing capital gains. Investments concentrated in an industry or group of industries may face more risks and exhibit higher volatility than investments that are more broadly diversified over industries or sectors.  Companies in the consumer discretionary sector are subject to changes in the overall international economy; interest rates; competition; consumer confidence; and individual disposable income and spending. The portfolio is also subject to the risks of product obsolescence, resource depletion and labor relations. Investments in companies in the energy sector may be subject to substantial government regulation, as well as risks involving changes in energy prices, international political instability, and liability for environmental damage and accidents resulting in loss of life or property. Derivatives may not work as intended and may result in losses. The value of your investment is also subject to geopolitical risks such as wars, terrorism, trade disputes, environmental disasters, and public health crises; the risk of technology malfunctions or disruptions; and the responses to such events by governments and/or individual companies. 

The Victory U.S. Small Cap Free Cash Flow Index aims to select high quality U.S. small-cap companies from its starting universe by applying profitability screens. It then selects companies with the strongest free cash flow yield that exhibit higher growth. The Index is rebalanced and reconstituted quarterly.

VictoryShares ETFs distributed by Victory Capital Services, Inc. (VCS). VCS is not affiliated with VettaFi.

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