Why Rate Cuts Could Fuel This Small-Cap ETF’s Next Move

As expected, the U.S. Federal Reserve (the Fed) cut interest rates by another 25 basis points on October 29, and now the capital markets are forecasting what moves the Fed may make for the remainder of the year. Either way, rate cuts could potentially be a boon for small-cap investors, and those investors should seek exposure beyond just the Russell 2000 Index. With this in mind, one may want to consider the VictoryShares Small Cap Free Cash Flow ETF (SFLO).

This free cash flow (FCF) ETF provides exposure to high FCF-yielding small-cap companies and may help investors uncover true value within the expansive small-cap universe. FCF can provide a snapshot of a company’s overall health and the remaining cash a company has after covering all expenses. It can be used to invest in growing the business, pay dividends, or pay down debt.

“If you’re looking for a valuation story across the asset classes, small-cap may be interesting at this time,” said VictoryShares’ Client Portfolio Manager Michael Mack during a webinar titled: AI, Valuations, and Concentration Risks: Why Free Cash Flow Matters More Than Ever.

Beyond Russell 2000 Index Exposure

Investors excited about the prospects of small-cap performance in a rate-cutting environment still have to be selective and exercise due diligence. As mentioned, selecting a fund that only tracks the Russell 2000 Index may not be enough, which is where SFLO may be beneficial. SFLO seeks to track the Victory U.S. Small Cap Free Cash Flow Index (the Index). As such, it provides exposure to small-cap companies that exhibit a high FCF yield.

Forward-Looking FCF

SFLO maintains a forward-looking approach. Rather than solely relying on past data from trailing cash flow figures, the Index looks closely at a company’s expected FCF (the combination of trailing and forward-looking projections of a company’s cash flows). The Index targets companies with attractive growth prospects that can continue growing their cash flow operations after deducting capital expenditures (Capex).

Because SFLO’s rules-based methodology uses FCF to select its holdings, the Index has the potential to tilt toward certain sectors that could see upside due to additional rate cuts. For example, the energy sector could benefit from reduced borrowing costs to fuel new projects, and the consumer discretionary sector could see an uptick in consumers purchasing big-ticket items due to lower financing costs. As of September 30, SFLO tilts heaviest toward the Energy sector (22.98% as opposed to the Russell 2000 Value Index’s 6.88%) and Health Care sector (16.57% versus the Russell 2000 Value Index’s 9.28%).

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.

For more news, information, and analysis, visit the Free Cash Flow Content Hub.

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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, visithttp://www.vcm.com/prospectus. Read it carefully before investing.

All investing involves risk, including the potential loss of principal. 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. 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. 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. 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. 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 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. This Index calculates free cash flow yield by dividing expected free cash flow by enterprise value. Expected free cash flow is the average of trailing 12-month FCF and next 12-month forward free cash flow. Enterprise value (EV) measures a company’s total value, often used as a more comprehensive alternative to equity market capitalization.

You cannot invest directly in an index.

Free cash flow yield is a financial solvency ratio that compares the free cash flow per share a company is expected to earn against its market value per share.

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

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