Smaller Stocks May Be Ready for Bigger Things

Despite Federal Reserve interest rate cuts, the Russell 2000 has seen only modest gains, indicating that patience is required for small-cap investors. The Neuberger Berman Small-Mid Cap ETF (NBSM) is presented as an actively managed SMID blend fund designed to navigate this environment by focusing on quality firms, leveraging less-covered opportunities, and strategically underweighting rate-sensitive sectors like healthcare. This approach aims to mitigate risks associated with highly leveraged companies prevalent in broader small-cap indexes, positioning the fund for potential upside as analysts project a 20% rise for the small-cap index over the next 12 months with anticipated rate cuts.

Analysis

The Russell 2000 Index has demonstrated only modest gains following recent Federal Reserve rate cuts, a reflection of the structural risks within the small-cap universe. Approximately half of the companies in the index are unprofitable and highly leveraged, making them sensitive to financing costs. In this environment, the Neuberger Berman Small-Mid Cap ETF (NBSM) is presented as a strategic alternative to broad-based passive exposure. As an actively managed small/mid-cap (SMID) fund, NBSM focuses on quality and seeks to capitalize on the relative lack of analyst coverage in the space, which can lead to mispriced opportunities. The fund's strategy is evidenced by its portfolio construction: it is significantly underweight the rate-sensitive healthcare sector and overweight industrials, positioning it to potentially benefit from defense and infrastructure spending. While lower rates are generally a tailwind for small-caps, NBSM's quality-oriented approach aims to reduce dependency on Fed policy. This positioning is notable given analyst expectations, cited by The Daily Upside, for the small-cap index to rise by as much as 20% in the next 12 months, outpacing the 11% forecast for the S&P 500.

Key Decisions for Investors

• Investors seeking small and mid-cap exposure should consider an actively managed, quality-focused approach, such as the NBSM ETF, to mitigate risks associated with the high prevalence of unprofitable and leveraged companies in the broader Russell 2000 index.
• Monitor the fund's sector tilts, as its significant overweight in industrials and underweight in healthcare represents a specific tactical bet on infrastructure tailwinds and a cautious stance on rate-sensitive segments of the market.
• Given that Wall Street analysts project a 20% upside for the small-cap index over the next year, patient investors may find opportunities in SMID-caps, but should favor strategies that are less dependent on Fed rate cuts for performance.