The Performance and Strategic Positioning of SMID Cap Value ETFs in a Shifting Rate Environment

The shifting rate environment of 2025 has placed SMID Cap Value ETFs at a crossroads, where their performance and strategic positioning are being tested by macroeconomic volatility, geopolitical tensions, and evolving investor preferences. As central banks navigate the delicate balance between inflation control and growth support, SMID Cap Value ETFs-both passive and active-have exhibited divergent trajectories. This analysis explores how active management strategies are reshaping risk-adjusted returns in this segment, particularly in the context of a market landscape marked by dispersion and uncertainty.

Performance Gaps and Benchmark Dynamics

In Q3 2025, the Harbor SMID Cap Value ETF returned 7.57% (net asset value), trailing the Russell 2500® Value Index's 8.17% return. This modest underperformance underscores the challenges faced by some SMID Cap Value ETFs in aligning with broad indices, especially as market conditions shift. However, not all active strategies have faltered. The Invesco S&P MidCap 400 Pure Value ETF (RFV) has delivered a 2025 year-to-date return of 8.0%, with a five-year annualized return of 19.4%, demonstrating that refined methodologies and active index construction can yield superior results.

The Avantis U.S. Large Cap Value ETF (AVLV), though focused on large-cap equities, offers a compelling case study: its 9.8% annualized return over five years outperformed the Russell 1000 Value index's 8.2%. This highlights the potential of active strategies that incorporate profitability filters and quality screens to enhance risk-adjusted returns, a principle increasingly relevant to SMID Cap Value ETFs.

Active Management in Volatile Markets

The 2025 rate environment has amplified the importance of active management in SMID Cap Value ETFs. T. Rowe Price's Small-Mid Cap ETF (TMSL), for instance, has outperformed its Russell 2500 benchmark by 170 basis points year-to-date. This success is attributed to its focus on high-quality companies with strong earnings, cash flow, and balance sheets, as well as its ability to dynamically adjust portfolios in response to macroeconomic shifts.

Manager commentary from T. Rowe Price further emphasizes the role of active strategies in navigating volatility. David Eiswert notes that the absence of a traditional credit cycle and rapid AI innovation have created a "data-dependent" policy environment, where nimble strategies can capitalize on inefficiencies. Similarly, Jennifer Martin highlights the constructive outlook for stock selection in a world of unsynchronized global cycles. These insights underscore the value of active management in identifying durable earnings potential amid uncertainty.

Risk-Adjusted Returns and Strategic Nuances

The volatility of 2025 has also exposed the limitations of passive strategies in SMID Cap Value ETFs. For example, the Harbor SMID Cap Core ETF has focused on high-quality businesses trading below intrinsic value, leveraging short-term uncertainty to identify long-term opportunities. ClearBridge Investments, meanwhile, has emphasized the elevated volatility of SMID-cap stocks due to their sensitivity to macroeconomic shifts and fluid policy environments.

Active strategies are increasingly incorporating profitability and valuation metrics to mitigate risk. Baron SMID Cap ETF, launched in December 2025, exemplifies this approach by targeting companies in high-growth sectors like cybersecurity and medical devices, balancing growth profiles with disciplined valuation. Such strategies aim to capture risk-adjusted returns while avoiding the pitfalls of market concentration-a critical consideration as mid-cap indices become increasingly dominated by a few high-momentum stocks according to Janus Henderson.

The Role of the Rate Environment

The 2025 rate environment has been a double-edged sword for SMID Cap Value ETFs. Historically, these stocks benefit from rate-cut cycles, as lower borrowing costs and improved liquidity boost their valuations. However, geopolitical tensions-such as the Iran-Israel conflict and U.S. tariff uncertainties-have introduced dispersion, favoring high-quality, fundamentally strong companies over weaker peers.

Leveraged and non-diversified ETFs, which constitute 27% of new 2025 ETFs, face additional headwinds in this environment. Derivatives costs and volatility drag can erode risk-adjusted returns, particularly for strategies lacking robust risk management frameworks. This further amplifies the appeal of active strategies that prioritize liquidity, tax efficiency, and structural flexibility according to T. Rowe Price.

Conclusion

As the 2025 rate environment continues to evolve, SMID Cap Value ETFs are being redefined by the interplay of active management, risk-adjusted returns, and macroeconomic volatility. While passive strategies face challenges in aligning with benchmarks, active ETFs like TMSL, RFV, and BCSM are demonstrating the value of dynamic, research-intensive approaches. Investors seeking resilience in this segment must prioritize strategies that emphasize quality, profitability, and adaptability-qualities that will likely determine the winners and losers in the years ahead.