FAQ small cap funds

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Flag of the United States.svg.png This article contains details specific to United States (US) investors. Acting on fund or ETF suggestions in it may have harmful US tax consequences for non-US investors.

FAQ small cap funds addresses the most Frequently Asked Questions (FAQ) regarding Vanguard small cap funds.

Basic questions

How many small cap funds does Vanguard provide?

Vanguard currently provides seventeen non-institutional small cap funds:

Active Index ETF
Strategic Small-Cap Equity (active small blend) VSTCX Small cap index NAESX Russell 2000 ETF VTWO
Explorer (active small growth) VEXPX Small cap index Admiral shares VSMAX Russell 2000 Growth ETF VTWG
Explorer Admiral shares VEXRX Tax-managed small cap index VTMSX Russell 2000 Value ETF VTWV
Explorer Value (active small value) VEVFX Small cap growth index VISGX S&P Small Cap 600 ETF VIOO
International Explorer (active international small growth) VINEX Small cap value index VISVX S&P Small Cap Growth 600 ETF VIOG
FTSE All World ex. U.S. Small Cap (International) Index VSFVX S&P Small Cap Value 600 ETF VIOV

What percentage of the total stock market do small caps represent?

About 10% small caps would equal the weighting of the total stock market. International small cap would also require about 10% to complete the FTSE All World ex. U. S. index. Note that whereas the Vanguard U. S. Total stock market and Total International index funds contain the market weight in small caps, the FTSE Index, holding large and mid cap stocks, does not.

Are small cap funds necessary in my portfolio?

If you desire to hold small cap allocations at market capitalization weightings you can hold a US Total Market Index fund and meet your allocation desires without adding a small cap fund. However, if your employer provided retirement plan provides you with an S&P 500 index fund and no other low cost options you may wish to add a small cap fund in your taxable account or personal retirement plan in order to mirror the market. (See Approximating total stock market for guidance).

You would also want to add a small cap fund to your portfolio if you desire to "tilt" your portfolio asset allocation towards higher small cap and/or value weightings than those provided by market cap weighting.

Currently, the Vanguard Total International index fund is the only Vanguard international index fund allocating market weights to international small cap stocks. If you hold any of the other Vanguard international index funds, you might want to add a small cap international index fund to your portfolio. (See Vanguard FTSE All-World ex-US Small-Cap Index Fund which suggests holding this fund in a 1:9 ratio with the FTSE-All-World ex-US index for those seeking market cap weighting. The combination of these two funds is a sensible choice for investors seeking total market weighting as the funds track exactly complementary indexes. Additional international small cap options are available at International small cap).

What are the expected returns of the different funds?

According to 30 year return estimates from William Bernstein and Rick Ferri small cap stocks can be expected to provide the following returns:

sources: - Portfolios Solutions LLC (2006). Reprinted with permission from Rick Ferri, CEO, Portfolio Solutions [1] and William Bernstein The Four Pillars of Investing [2]
Asset Real Returns With 3% Inflation Risk (Standard deviation)
US Small Cap Stocks 5.0 - 6.0 8.0 - 9.0 20.0
US Small Value Stocks 7.0 - 8.0 10.0 - 11.0 25.0
International Small Company Stocks 5.0 - 6.0 8.0 - 9.0 22.0

Vanguard index funds can be expected to provide the market return, less expenses and transaction costs. Vanguard active funds offer the hope of providing excess returns to the market, at the risk of providing less than market returns.

What does "tilting" to small mean and how much should I tilt?

John Bogle on tilting:
"Impressed both by the long-term performance (and recent performance) of value stocks and small-cap stocks, some investors hold the all-market (or S&P 500) index fund as the core, and add a value index fund and a small-cap index fund as satellites. I'm skeptical that any kind of superior performance will endure forever. (Nothing does!) But if you disagree, it would not be unreasonable to hold, say, 85 percent in the core, another 10 percent in value, and another 5 percent in small cap. But doing so increases the risk that your return will fall short of the market's return, so don't push too far."
-- The Little Book Of Common Sense Investing, p.206.

Financial experts [3] often recommend that investors should use index mutual funds to invest in entire markets, or, invest in funds that approximate the total market. Other portfolio theorists advise holding portfolios that tilt toward small and value stocks. [4] [5] In general, the stock market is composed of 3 levels of market capitalization and 3 styles, resulting in a 3 x 3 "style" box. As defined in the style box for VTSMX [6], the majority of the US Market (the Total Stock Market or "TSM") is held in large caps. Therefore, this fund (representing the US Market, or the "Market") is defined as a "cap weighted" market.

Total Stock Market Index Fund Style Box (%)
Value Blend Growth
Large Cap 26 22 24
Mid Cap 6 6 7
Small Cap 3 3 3
Bill Shultheis' Coffeehouse Portfolio, employing 4x25 value and small cap tilts

The intent is that these distribution percentages, by definition, accurately represent the composition of the entire market. Gain and loss over time represents the movement of the market as a whole.

If you invest $1.00 in a total market index fund, each stock receives the same amount of your dollar in proportion to it's cap weight. The largest stock gets 100 times the amount of a company 100th it's size. Therefore, no company gets more or less than that determined by it's market capitalization.

The Small cap styles represent 9% (3 + 3 + 3) of the total market. Tilting to Small means overweighting your portfolio to hold more than 9% of Small cap stocks.

Historically, value stocks and small stocks have provided higher returns than large blend and growth stocks (in both domestic and foreign markets). The theoretical basis posited for these higher returns states that small stocks and value stocks are riskier than large and growth stocks, and that the higher returns compensate investors for higher risk. [7] [8] [9] Based on theory and past performance, some investors choose to add additional value and small stocks to their portfolios. Many investors who tilt employ what is termed a 4x25 allocation consisting of equal parts of 25% large blend; 25% large value; 25% small blend; and 25% small value. Tilters employ blend indexes for growth stock exposure in response to the long term performance of small cap growth stocks. [10] [11] Other tilters, valuing greater portfolio simplicity, overweight small value stocks by adding a small value fund to the market portfolio (see John Bogle on tilting in the sidebox quote). [note 1] Overweight means increasing your holdings to more than is naturally in the market profile.


  • In some cases (higher expected returns), tilting can allow the investor to add more fixed-income securities (bonds) and less equity to the total portfolio.
  • The investor's behavior during bear and bull markets can influence results. An investor who tilts must be able to hold to the allocation during periods when the tilted equity portfolio under performs the market portfolio. An investor should also resist the temptation to engage in "performance chasing", that is buying or selling a size or style tilt based on recent performance.
  • Tilted portfolios require long holding periods as the market, value, and size factor returns often rotate over time. [12]
  • Although small and value stocks have higher expected returns than growth stocks, investors should recognize that the record of realized returns does not assure a similar pattern in the future. The timing and magnitude of the size and value premiums will always be uncertain, i.e. past performance does not predict future performance.

My company plan does not have a small cap fund, how can I add one?

If you would like to invest in a small cap fund outside of your company plan you can place the investment in either your personal retirement plan (Traditional IRA or Roth IRA) or in your taxable account. (For guidance on asset location considerations refer to Principles of tax-efficient fund placement).

How tax-efficient are the small cap funds?

Actively managed small cap funds are not very tax efficient, as the distribution history of the Vanguard Explorer fund and the Vanguard International Explorer Fund demonstrate. Active funds tend to distribute hefty capital gains distributions. Vanguard small cap index funds are currently very tax efficient as a result of the following three factors:

  1. The benchmarking of the funds to CRSP and FTSE indexes which utilize transition bands between size and valuation metrics. These bands tend to reduce the turnover of stocks as they migrate across indexes, which helps reduce taxable gain realization.
  2. The accumulation of realized loss carryforwards from the 2000-2002 and 2008 bear markets. These carryforwards can be applied to offset future realized gains in the funds through fiscal year 2017. Active small cap funds tend to realize gains at a much quicker rate than do index funds. This tendency results in active funds depleting loss carryforwards much faster than index funds.
  3. The ETF share classes of Vanguard index funds, through the institutional creation and redemption process of ETF shares, serve to enhance the funds' tax efficiency by gradually removing low basis stock from the fund portfolios and by stabilizing the funds' level of loss carryforwards. [note 2]

Under current law, qualified dividends are taxed at lower capital gains tax rates. The qualified dividends a small cap index fund passes on to shareholders is reduced by the holding periods of a fund's purchases and sales of stocks and by the extent of a fund's holding of REITS, whose dividends are unqualified. [note 3] Small cap value index funds provide higher dividend payouts than do small growth or small blend indexes. Vanguard's most tax efficient small cap fund is the Tax-Managed Small-Cap Fund, which has never distributed a capital gain distribution in its ten year history and which has provided 100% qualified dividends to its shareholders since the provision was enacted. Since the 2004 advent of ETF share classes in the index funds, none have distributed a capital gains distribution:

Small Cap Index Funds Qualifying Dividends
Year Vanguard Small-Cap Index Fund Vanguard Small-Cap Growth Index Fund Vanguard Small-Cap Value Index Fund Vanguard Tax-Managed Small Cap Fund Vanguard Russell 2000 ETF Vanguard Russell 2000 Growth ETF Vanguard Russell 2000 Value ETF Vanguard S&P 600 ETF Vanguard S&P 600 Growth ETF Vanguard S&P 600 Value ETF
2011 69.07% 85.53% 69.07% 100.00% 61.69% 100.00% 56.55% 74.51% 79.47% 83.53%
2010 73.31% 87.49% 73.51% 100.00% 58.33% 100.00% 61.25% 79.41% 90.39% 78.04%
2009 72.16% 78.89% 73.90% 100.00% - - - - - -
2008 67.68% 70.11% 71.76% 100.00% - - - - - -
2007 76.10% 83.16% 75.52% 100.00% - - - - - -
2006 69.47% 93.56% 75.52% 100.00% - - - - - -
2005 72.15% 100.00% 66.93% 100.00% - - - - - -
2004 70.09% 100.00% 63.87% 100.00% - - - - - -

The Vanguard FTSE All-World ex-US Small-Cap Index Fund like a majority of international small cap funds and ETFs has distributed a small capital gain early in its history. The fund's passive management approach and ETF share class structure should result in improved tax efficiency over the long term. The fund also qualifies for the foreign tax credit for taxable investors.

See also



  1. 30 Year Market Forecast
  2. The Four Pillars of Investing (2002), page 72
  3. See John Bogle, The Telltale Chart
  4. Eugene Fama Jr., The New Indexing, July 2000.
  5. Truman A. Clark, The Dimensions of Stock Returns, September 2007.
  6. Vanguard's Total Stock Market Index Fund (VTSMX) approximates the total market by investing in over 3,000 stocks, which is representative of the whole U.S. market
  7. Rolf W. Banz, "The Relationship Between Return and Market Value of Common Stocks," Journal of Financial Economics, 9 (1981), pp. 3-18
  8. Davis, James L., Fama,_Eugene_F. and French,_Kenneth_R., "Characteristics, Covariances, and Average Returns: 1929-1997" (February 1999). Center for Research in Security Prices (CRSP) Working Paper No. 471. Available at SSRN: http://ssrn.com/abstract=98678 or DOI: 10.2139/ssrn.98678
  9. Fama,_Eugene_F. and French,_Kenneth_R., "Value Versus Growth: The International Evidence" (August 1997). Available at SSRN: http://ssrn.com/abstract=2358 or DOI: 10.2139/ssrn.2358
  10. William Bernstein, Small Cap Growth Indexing and the Multifactor Threestep,Efficient Frontier, April, 1999.
  11. William Bernstein, The Small-Growth Indexing Anomaly, Efficient Frontier, Summer 2001.
  12. William Bernstein, Factor Rotation, Efficient Frontier, Summer 2000.

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