Time for a Fundamental Approach?

Macroeconomic conditions for 2026 may seem a little bit shaky, but one area where advisors and investors might find great opportunities is actually within small-caps. 

Sure, this is likely not the first year that folks are hearing that small-caps might start threatening to outperform their large-cap counterparts. However, we’re starting to see the pieces fall into place to help make that theory a reality. 

While the Federal Reserve’s rate-cutting agenda remains as uncertain as ever, one thing that’s clear is that pressure is mounting on the central bank to trim interest rates soon. And with new leadership set to take over the Fed later in 2026, more rate cuts could certainly be on the agenda. While rate cuts benefit businesses of all sizes, small-caps in particular can leverage these lower rates to foster growth. 

Rate cuts aren’t the only thing that can work in favor of small-caps, either. Lower regulations from the Federal government, AI momentum, and the ongoing U.S. reshoring boom are all working in favor of these companies. These conditions are all playing out while many small-caps are trading at attractive valuations, as well. 

However, advisors and investors looking to amplify their small-cap exposure may want to be careful when choosing their small-cap exposure. Yes, one could certainly go with a tried-and-tested market cap weighted fund like the iShares Russell 2000 ETF (IWM), but by doing so, you’re exposed to both the good and the bad parts of the Russell 2000. Given the risky nature of small-cap investing, it could pay off to look for a fund that takes a more fundamental approach.

The Advantages of Fundamentals

For instance, take a closer look at the O’Shares U.S. Small-Cap Quality Dividend ETF (OUSM). A small-cap ETF with a quality tilt, OUSM looks to fill its portfolio with companies with low volatility, high quality, and plenty of dividends. 

OUSM’s strategy focuses on providing similar results to the O’Shares U.S. Small-Cap Quality Dividend Index (OUSMX). This index takes a factor-based approach, evaluating individual securities based on the aforementioned quality, volatility, and dividend metrics. With this index as a guideline, OUSM can tap into the opportunity within high quality small-caps. At the same time, it can look to mitigate much of the volatility potentially seen with a more broad approach. 

This differentiated approach to small-caps is reflected in OUSM’s top sector holdings. For instance, as of January 26, 2026, IWM’s top three sectors in its portfolio are industrials, health care, and financials. Meanwhile, the top three sectors in OUSM’s portfolio are industrials, financials, and consumer discretionary. Health care sits as the fifth-largest sector in the fund. 

We are still in the early stages of a potential small-cap comeback. Given that, investors and advisors have plenty of time to recalibrate their portfolios. If a more fundamental-based approach to small-cap investing sounds appealing, it could pay off to look into OUSM and its respective index before the small-cap rally really takes off. 

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

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