VB vs. IJR: A Value Investor's Checklist for Small-Cap ETFs

For the disciplined investor, the small-cap market presents a classic opportunity. The asset class is trading at one of its cheapest levels relative to large caps in 50 years, despite earnings growth that has roughly kept pace with its larger peers. This valuation gap, where small-cap stocks now trade at about a 20% discount to parity, represents a significant departure from historical norms and a potential entry point for patient capital.

Both leading ETFs, Vanguard Small Cap ETF (VB) and iShares Core S&P Small-Cap ETF (IJR), provide a low-cost, passive vehicle to access this market. Their expense ratios are exceptionally low, sitting below 0.10% for each fund. This cost efficiency is critical, as it ensures the majority of any future compounding returns flows directly to the investor rather than to fees.

A key differentiator lies in diversification. VB holds over twice as many individual stocks as IJR, with a portfolio of 1,357 holdings compared to IJR's 632. This wider diversification offers a more granular exposure to the small-cap universe, potentially smoothing out idiosyncratic risks within the sector. For an investor seeking a broad, low-turnover stake in the entire small-cap market, this breadth is a material advantage.

Assessing Quality and Competitive Moats

For the value investor, the most critical question is not just price, but quality. Do the underlying businesses possess durable competitive advantages, or "moats," that can protect profits and enable long-term compounding? Both VB and IJR, as broad, rules-based ETFs, provide no tilt toward high-quality companies. They are designed to mirror their respective indices-CRSP US Small Cap Index for VB and S&P SmallCap 600 Index for IJR-holding every stock in proportion to its market capitalization. This approach ensures diversification but also means the funds are equally exposed to companies with weak moats and those with strong ones.

Historically, the data is clear: high-quality stocks have outperformed low-quality ones over full market cycles. This long-term advantage is not captured by these broad ETFs. Their portfolios are a composite of the entire small-cap universe, which includes a wide spectrum of business models, from capital-light service firms to capital-intensive manufacturers. The ETFs themselves do not discriminate based on management quality, return on capital, or pricing power. An investor buying either fund is accepting this mix as a given.

From a risk perspective, the funds have similar profiles. Both have betas near 1.10, indicating they are expected to move about 10% more than the broader market in either direction. This near-identical sensitivity suggests their risk exposures are broadly comparable, driven by the shared characteristics of the small-cap segment rather than any fundamental difference in the quality of their holdings. The choice between them, therefore, comes down to cost, diversification, and liquidity-factors already examined-rather than a deliberate selection for superior business franchises.

The Dividend Yield Trade-Off and Long-Term Compounding

The dividend yield difference between the two funds is minimal and not a material factor for a value investor. IJR offers a yield of 1.4%, slightly above VB's 1.3%. This tiny gap reflects a modest tilt in VB's index toward growth-oriented sectors like technology and industrials, which often pay lower dividends than more mature, capital-intensive businesses. For an investor focused on intrinsic value, this yield spread is noise. The true measure of success is total return-the combination of capital appreciation and any income received. In that light, VB has already demonstrated a slight edge, posting a higher total return over the past five years.

What matters far more over the long term is the compounding effect of costs and tracking error. Both funds are exceptionally inexpensive, but VB holds a slight fee advantage with an expense ratio of 0.05% versus IJR's 0.06%. While this difference seems trivial, it compounds significantly over decades. A 10-basis-point annual savings on a large investment can add up to tens of thousands of dollars in net returns over a 30-year horizon. This is the discipline of value investing in action: minimizing friction to allow the underlying business growth to work for you.

The bottom line is that for a patient capital allocator, the choice between VB and IJR is a decision about the efficiency of the vehicle, not the current income it provides. The focus should remain on the undervalued asset class itself-the small-cap market trading at a historic discount-and the long-term compounding power of a low-cost, broadly diversified stake in it. The dividend yield is a footnote; the total return, driven by fees and performance, is the main event.

The Value Investor's Checklist and Catalysts

For the value investor, the decision between VB and IJR boils down to a simple checklist. The first item is valuation, and here the small-cap market itself presents a compelling case. The asset class is trading at one of its cheapest levels relative to large caps in 50 years, with small-cap stocks now priced at about a 20% discount to parity. This historical discount is the foundational reason for interest, creating a potential margin of safety.

The second item is diversification. On this front, VB offers a clear advantage. With a portfolio of 1,357 holdings, it provides wider exposure than IJR's 632 stocks. This broader net is a material benefit for an investor seeking to capture the entire small-cap universe without tilting toward any single sector or company.

Cost is the third, and perhaps most straightforward, item. Both funds are exceptionally inexpensive, but VB holds a slight edge with an expense ratio of 0.05% versus IJR's 0.06%. In the long-term compounding game, this 10-basis-point difference is not noise; it is a tangible, recurring savings that works in the investor's favor.

The fourth item is quality. This is where the ETFs themselves fall short. As broad, rules-based vehicles, they do not capture the fundamental advantage of high-quality businesses. The evidence shows that over the past 20 years, high-quality stocks have outperformed low-quality ones. Yet in 2025, the earnings quality factor posted its worst performance in 30 years. This divergence between short-term momentum and long-term quality trends is a key market dynamic. The value investor must recognize that these ETFs offer no tilt toward quality; they are a pure play on the small-cap asset class, which includes both strong and weak moats.

Looking ahead, a major catalyst for small caps is a rotation into the asset class as economic conditions improve. Historically, small-cap stocks have delivered strong outperformance following recessions, a pattern that aligns with the quality factor's tendency to offer shelter during downturns. The current environment-where small caps are deeply undervalued relative to large caps and momentum has driven speculative rallies-sets the stage for a potential reversion to longer-term norms.

The key risks are a prolonged market focus on large-cap growth and the inherent volatility of small-cap stocks. The market's recent momentum has been heavily skewed toward large caps, particularly AI-driven names, which could continue to pressure small-cap valuations. Furthermore, small-cap stocks are inherently more volatile than their larger peers, making them a more challenging asset class to hold through periods of turbulence. For the patient investor, these risks are part of the price of admission for a potential bargain.