This is a compelling small-cap portfolio.

by Alex Bryan
Schwab U.S. Small-Cap ETF

Schwab U.S. Small-Cap ETF SCHA is among the best U.S. small-cap funds available. This is a well-constructed index portfolio that effectively diversifies risk and enjoys a sizable cost advantage over its peers. It earns a Morningstar Analyst Rating of Gold.

The fund tracks the market-cap-weighted Dow Jones U.S. Small-Cap Total Stock Market Index. This index has a slightly larger market-cap-orientation than the Russell 2000 Index, but it is a better investment portfolio and is still representative of the small-blend Morningstar Category. Because there is less money tied to this index, changes to the index don't move prices as much here, so the managers should get more favorable prices. The portfolio's larger market-cap orientation and larger minimum float requirement also help reduce transaction costs because larger and more regularly traded stocks tend to be cheaper to trade. Its index uses generous buffer rules to mitigate unnecessary turnover, which should further reduce transaction costs.

This is a well-diversified portfolio of more than 1,700 stocks, and it has less than 5% invested in the top 10 holdings. These small-cap stocks tend to be riskier than their larger counterparts, but they may offer higher returns to compensate. That said, they can lag large stocks for decade-long spans. The best reason to own them is for diversification.

While small-cap stocks are more likely to be mispriced than their larger counterparts, as they tend to attract less attention, most active managers haven't outperformed well-constructed indexes like this one over the long term. This portfolio is representative of small-cap active managers' aggregate holdings, so its performance gross of fees should be similar to the average active managers' gross of fees. But it should come out ahead after fees, given its sizable cost advantage and low turnover, which mitigate transaction costs.

From its inception in November 2009 through June 2019, the fund beat the small-blend  category average by 1.97 percentage points annually. This was partially due to its cost advantage and smaller-than-average cash drag.

Portfolio Construction

The fund tracks an index that effectively diversifies risk, promotes low turnover, and accurately represents its target market segment, supporting its Positive Process Pillar rating. The fund tracks the Dow Jones U.S. Small-Cap Total Stock Market Index, which ranks U.S. stocks by market capitalization, excludes the largest 750 stocks, and targets the next largest 1,750. But when it reconstitutes each year in September, current holdings that rank between the largest 601st and 3,000th by market cap are included first to reduce unnecessary turnover. Like most index peers, the fund adjusts its holdings' weightings to reflect free-float market cap. To qualify for inclusion, at least 10% of new constituents' shares outstanding must be publicly traded. New constituents must also pass a minimum trading volume threshold. Current holdings do not have to pass these liquidity hurdles.


Schwab charges a razor-thin 0.04% fee for this fund, which is among the lowest in the category. It earns a Positive Price Pillar rating. During the trailing three years through June 2019, the fund beat its benchmark by 1 basis point annually, recouping its entire fee through a combination of savvy portfolio management techniques and securities lending.

S&P 500 index data: S&P 500 Copyright @ 2019

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