For decades, small-cap value was one of the most potent factor combinations, but that compelling history doesn’t mean small-cap value wins out every year. There are times when “junkier” small stocks beat broader small-cap indexes.

That’s been the case over the past three years as the Russell 2000 Index beat its value counterpart by more than 800 basis points. However, investors shouldn’t take their eyes off small-cap value. Some experts see a potential resurgence for that style coming in 2026. That could bode well for ETFs such as the WisdomTree U.S. SmallCap Dividend Fund (DES).

DES, which turns 20 years old next June, is an example of an ETF that’s been “victimized” by market participants favoring riskier small-caps. That said, it has generated decent returns over the past three years. Importantly, DES has the ingredients with which to participate in a small-cap value rebound, or maybe even lead that comeback.

DES Details Matter

The $1.86 billion DES is pertinent in the small-cap value rebound conversation. That’s because it’s not a run-of-the-mill cap-weighted fund. The ETF follows the dividend-weighted WisdomTree U.S. SmallCap Dividend Index. That implies that DES has both quality and value traits. The former is something to consider. Market participants could rapidly move from unprofitable small-caps to those with better quality profiles.

“Low-quality rallies will come and go. Investors must pick strategies that can win over the long haul and be patient. Focusing on high-quality, profitable businesses is one way to do that,” noted Morningstar’s Eric Schultz. “Aggregate profitability metrics like net margins, return on assets, and return on invested capital higher than those of the benchmark usually indicate a high-quality portfolio.”

The status of DES member firms also implies some level of profitability. That can be hard to come by in some small-cap gauges. For example, it’s estimated that more than a third of Russell 2000 member firms aren’t profitable. As Morningstar’s Schulz points out, 8% of that index’s components have never turned a profit.

Still, investors have bid many of those financially flimsy small-caps higher this year. That indicates that a casino-like mentality is permeating the small-cap space. That won’t last forever. When cooler heads prevail, investors that want to maintain exposure to smaller stocks could turn to more prudent options such as DES.

“Swelling stock valuations, rather than underlying business improvements, drove the gains; the price/sales ratio of the average profitless stock jumped from the mid-single digits at the beginning of the year to almost 20 recently. In other words, market participants were willing to pay higher prices for the promise of future earnings rather than actual current profits,” concluded Schulz.

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