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The small-cap space has been outperforming its large-cap brethren over the past three months. This outperformance came on the back of optimism over President-elect Donald Trump’s policies, which may lead to faster economic growth. iShares Russell 2000 ETF (IWM - Free Report), the ultra-popular small-cap ETF, climbed 9.4% compared with a gain of 7.5% for the ultra-popular large-cap ETF, SPDR S&P 500 ETF Trust (SPY - Free Report).

While many ETFs have risen, we have highlighted five from the small-cap space that have been at the forefront of the rally over the last three months.

These include the likes of Motley Fool Small-Cap Growth ETF (TMFS - Free Report), First Trust Small Cap Growth AlphaDEX Fund (FYC - Free Report), Vanguard Small-Cap Growth ETF (VBK - Free Report), Janus Henderson Small Cap Growth Alpha ETF (JSML - Free Report), and First Trust Dow Jones Select MicroCap Index Fund (FDM - Free Report).

Inside the Outperformance

Trump's policies could provide more stimulus to the U.S. economy and benefit small-caps the most. He proposed reducing the statutory corporate income tax rate from 21% to 15% and extending tax cuts passed during his first term — set to expire at the end of next year. With reduced tax expenses, profits for smaller companies would grow.

Trump’s administration is focused on deregulating many industries, such as energy and finance, to reduce businesses' compliance costs. For small-cap companies, which often lack the financial resources of larger firms to manage regulatory compliance, reduced regulations mean lower operational costs. This shift will allow small-cap businesses to operate with increased profitability. 

Trump’s proposed tariffs against major U.S. trading partners would likely boost the greenback. A strong dollar provides an edge to domestic-focused companies, as small-caps do not have much exposure to the international market. Trump's protectionist stance could benefit domestic producers, as higher import tariffs raise costs for foreign competitors.

Further, lower rates have been providing a boost to pint-sized stocks. As these companies have a higher debt burden (mostly at floating rates), lower rates lead to reduced borrowing costs, helping small businesses expand their operations easily and resulting in increased profitability. This, in turn, stimulates economic growth.

As small-cap companies are more domestically tied, they are poised to outperform when the economy improves. Powell said that the U.S. economy is in "remarkably good shape." One of Powell’s favorite barometers of the economy — the Beige Book — showed that economic activity increased slightly in November, and businesses grew more upbeat about demand prospects, per CNBC TV18.

Moreover, small-cap stocks are considered safer and better plays if political issues or economic turmoil creep into the picture. Escalating tensions in the Middle East and the ongoing Russia-Ukraine war will likely continue to drive the appeal for small-cap stocks.

ETFs in Focus

Here is a brief review of the previously mentioned ETFs to consider.

Motley Fool Small-Cap Growth ETF (TMFS - Free Report)

The Motley Fool Small-Cap Growth ETF offers exposure to high-quality U.S. small-cap companies that are believed to be undiscovered or underappreciated, and it actively targets innovative businesses with the characteristics we think are essential for long-term growth. It holds 35 stocks in its basket, with key holdings in industrials, information technology, and healthcare. 

The ETF has accumulated $100.9 million in its asset base, and it charges 85 bps in annual fees. Additionally, it trades in an average daily volume of 13,000 shares. 

First Trust Small Cap Growth AlphaDEX Fund (FYC - Free Report)  

The First Trust Small Cap Growth AlphaDEX Fund offers exposure to small-cap growth stocks and follows the Nasdaq AlphaDEX Small Cap Growth Index. It holds a well-diversified portfolio of 264 stocks, with each accounting for less than 1.4% share. 

The fund has amassed $449 million in its asset base, and it charges 71 bps in annual fees. It trades in an average daily volume of 35,000 shares, and it has a Zacks ETF Rank #3 (Hold) rating.

Vanguard Small-Cap Growth ETF (VBK - Free Report)

The Vanguard Small-Cap Growth ETF tracks the CRSP US Small Cap Growth Index, while holding 610 stocks in its basket. From a sector look, technology takes the top spot at 21.4% share while industrials, healthcare, and consumer discretionary round off the next three spots, with double-digit exposure each. 

The product has amassed $20.7 billion in its asset base while trading in a solid volume of around 255,000 shares. It charges 7 bps in fees per year, and it has a Zacks ETF Rank #2 (Buy) rating.

Janus Henderson Small Cap Growth Alpha ETF (JSML - Free Report)  

The Janus Henderson Small Cap Growth Alpha ETF invests in resilient growth companies with proven operational excellence to provide investors with the opportunity to experience the long-term growth potential of the small-cap asset class through a variety of market environments. It follows the Janus Henderson Small Cap Growth Alpha Index. The ETF holds 206 stocks in its basket, with key holdings in industrials, healthcare, information technology, and financials.

The ETF has been able to manage assets worth $267.1 million, and it trades in a lower volume of 8,000 shares a day on average. It charges 30 bps in annual fees, and has a Zacks ETF Rank #3 (Hold) rating.

First Trust Dow Jones Select MicroCap Index Fund (FDM - Free Report)

The First Trust Dow Jones Select MicroCap Index Fund tracks the Dow Jones Select Microcap Index, which represents micro-cap stocks that are comparatively liquid and have strong fundamentals. It holds 140 stocks in its basket, with key holdings in financials, industrials, consumer discretionary, and energy.

The fund has AUM of $188.8 million, and it trades in an average daily volume of 16,000 shares. It charges 60 bps in annual fees, and it has a Zacks ETF Rank #3 (Hold) rating.

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