Small caps underrated

Great values to be found for aggressive investors

It’s not surprising that gold and materials are the main drivers of the strong first half posted by the TSX. The gold price has been surging since June of last year, driven by central bank purchases and by investors seeking safe havens during a period of market turbulence.

As for materials, the price for some key metals is in the stratosphere. Copper was trading at record highs, even before being given a further boost by Donald Trump’s latest tariff threat. Platinum has just pulled back after touching a new record high. Uranium is ahead about 20% from its March low.

None of this should surprise readers who have been watching the markets. But what they may not have noticed is the strong showing of Canadian small-cap stocks in recent years. Over the past three years, the return on the S&P/TSX Small Cap Index is the same as the TSX Composite. So far in 2025, small caps are ahead 14.62%, compared with 9.28% for the Composite. Many of these small companies are in the high-flying materials sector.

Small caps underrated

Small caps tend to be underrated by many investors. For years, they were dismissed as mainly consisting of unprofitable start-ups with great stories and no profits. In reality, there are some tremendous values to be found in the Canadian small cap universe, but many investors regard it as too risky.

Certainly, small caps tend to be more volatile than large-cap blue chips like the major banks. But you can reduce the risk by investing in a diversified portfolio of 10-15 quality small caps, or by buying units in an ETF that focuses on the sector.

One to consider is the iShares S&P/TSX SmallCap Index ETF (TSX: XCS).It invests in a portfolio that replicates the performance of the index of the same name, net of expenses.

The portfolio is about what you’d expect in a Canadian small-cap fund, with a heavy focus on materials (including gold mines) and energy. Together, they make up about 55% of the fund’s assets under management.

With that type of composition, you’d expect this to be a highly volatile fund. It has the potential to be, but over the past five years it has lost money only once, a dip of 9.22% in 2022. It gained 18.4% in 2024 and is ahead 12.5% year-to-date. The five-year average annual compound rate of return to the end of June was 14.8%.

This ETF was launched in May 2007 and has about $145 million in assets under management. The MER is 0.6%, which is on the high side for a passively managed fund. Distributions are paid quarterly and can vary significantly. The trailing 12-month yield is 1.9%.

The fund has 245 holdings with only one, New Gold Inc., having a weighting of over 2%. This means there are no big bets on any one stock. But, as mentioned, there are big bets on specific sectors. If the price of gold went into a sustained decline, it would certainly have a negative effect on the fund’s performance. That’s the risk you take.

For years, U.S. small cap stocks were a better bet than Canadian companies, but that’s not the case at this time. The iShares S&P U.S. Small-Cap Index ETF (TSX: XSMC) is down about 9.6% year to date. A look at the portfolio explains why. This ETF is heavily invested in financials and industrials. Materials and energy account for only 9% of the portfolio.

Bottom line: Aggressive investors who don’t have small cap exposure in their portfolios may wish to add units of XCS to their holdings.

Gordon Pape is one of Canada’s best-known personal finance commentators and investment experts. He is the publisher of The Internet Wealth Builder and The Income Investor newsletters, which are available through the Building Wealth website.

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Notes and Disclaimer

Content © 2025 by Gordon Pape Enterprises. All rights reserved. Reprinted with permission. The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned carry risk of loss, and no guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting, or tax advice. Always seek advice from your own financial advisor before making investment decisions.

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