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Investment Strategy2025-09-27

Small-Cap Value ETF AVUV Leads the Market, Factor Investing Strategy Back in the Spotlight

Small-cap value stocks are outperforming large-caps, with AVUV ETF showing strong momentum. As market rotation validates the effectiveness of factor investing strategies, the importance of style diversification is once again coming to the fore.

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Small-cap value stocks are leading the market, drawing renewed attention to AVUV (Avantis U.S. Small Cap Value ETF). As expectations for interest rate cuts grow, the valuation appeal of small-cap stocks has increased, accelerating style rotation. The importance of portfolio diversification through factor investing strategies is once again in focus, prompting investors to revisit style diversification in their asset allocation.

AVUV's Performance and Investment Philosophy

AVUV rose 4.7% over the past month, significantly outpacing SPY (2.1%) and QQQ (2.8%). AVUV takes a multi-dimensional approach that goes beyond simply screening stocks by market cap and valuation—it also considers profitability and investment quality. The fund’s current average P/E ratio of 13.2x reflects a substantial discount compared to large-cap stocks, suggesting the potential for long-term excess returns. Given the relatively lower market efficiency in small-cap value stocks, active selection strategies tend to be more effective in this space.

Market Cycles and Style Rotation

Current market conditions are creating a favorable environment for small-cap value stocks. Expectations for interest rate cuts are particularly positive for small-cap companies with higher leverage, and value stocks have historically tended to outperform growth stocks in the early stages of economic recovery. When using an asset allocation calculator, allocating 5–15% of your portfolio to small-cap value ETFs like AVUV can help capture opportunities arising from market cycles. Combining AVUV with large-cap ETFs such as SPY or QQQ can maximize the benefits of style diversification.

A Long-Term Perspective on Factor Investing

Academic research has shown that small-cap and value factor premiums deliver excess market returns over the long term. However, these premiums can be highly volatile in the short run and may underperform for extended periods. When investing in factor ETFs like AVUV, it is important to take a long-term view of at least 5–10 years and maintain the patience not to overreact to short-term results. A strategy of regularly rebalancing using a rebalancing calculator while waiting for factor premiums to materialize tends to be effective.

Risk Management and Portfolio Construction

Small-cap value stocks carry higher volatility and liquidity risk compared to large-caps. In particular, during market downturns, AVUV may experience larger drawdowns than SPY, so the allocation within the overall portfolio should be determined carefully. As a general guideline, it is recommended to limit small-cap ETFs to 10–25% of the total equity portfolio. Additionally, since the relative performance of small-cap and large-cap stocks shifts with economic cycles, employing a dynamic rebalancing strategy that accounts for market conditions can be beneficial.

Conclusion

The strong performance of small-cap value ETF AVUV underscores the importance of factor investing and style diversification. Over the long term, a systematic approach to factor investing can improve the risk-adjusted returns of a portfolio. We encourage you to use an asset allocation calculator and a rebalancing calculator to maintain appropriate weightings and effectively capture opportunities as market cycles evolve.

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