Nervous About Big Tech? This Vanguard Value ETF Is Where the Money Is Rotating
Factor rotation may be underway: Concerns surrounding AI spending and expensive mega-cap valuations have helped small-cap value stocks outperform the S&P 500 so far in 2026.
Small-cap value is a long-term strategy: VBR combines the size and value factors identified by Eugene Fama and Kenneth French, but both can spend years out of favor before rewarding patient investors.
Use it as a complement, not a replacement: VBR's broad diversification, low 0.05% expense ratio, and attractive valuations make it a strong satellite holding alongside a core broad-market ETF.
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The Magnificent Seven have dominated markets for years, but investors are beginning to ask tougher questions about just how much future growth is already priced in. A big reason is the extraordinary pace of artificial intelligence capital spending. The hyperscalers continue to pour hundreds of billions of dollars into data centers, chips, networking equipment, and power infrastructure. That's starting to shift the conversation away from revenue growth and toward return on investment. Eventually, all of that spending has to generate meaningful cash flows.
There are also growing concerns about circular financing within the AI ecosystem. The largest cloud providers purchase enormous quantities of AI chips from semiconductor companies, while those chipmakers rely on the hyperscalers to keep buying ever-larger volumes. Data center developers, equipment suppliers, utilities, and software vendors all depend on the same handful of customers continuing to spend aggressively. It has led some investors to draw comparisons with the buildup preceding the dot-com bubble
Whether those comparisons prove accurate remains to be seen. What is clear is that leadership has broadened considerably in 2026. As of July 31, the Vanguard S&P 500 ETF (VOO) has returned 10.16% year to date. One of the more surprising outperformers has been the Vanguard Morningstar Small-Cap Value ETF (VBR) , which has gained 16.70%.
Small-cap value has spent much of the past decade in the shadows as large-cap growth stocks, led by the Magnificent Seven, dominated returns. It's far too early to declare a lasting factor rotation, but the recent performance is enough to put the strategy back on investors' radar, particularly for those who believe today's market valuations have become stretched.
Small-cap stocks are companies with relatively modest market capitalizations compared with large-cap businesses. Because they're generally earlier in their corporate life cycle, they may have greater room to grow, although they also tend to experience higher volatility.
Value stocks, meanwhile, are companies that trade at relatively inexpensive valuations based on measures such as earnings, book value, or cash flow. Investors typically buy them with the expectation that the market has become overly pessimistic about their prospects.
The idea of combining these characteristics gained prominence through the work of economists Eugene Fama and Kenneth French. Their factor research suggested that certain characteristics could help explain long-term differences in stock returns. Two of the best known are the size factor, which historically favored smaller companies over larger ones, and the value factor, which historically rewarded lower-priced stocks relative to their fundamentals.
Putting the two together creates a small-cap value strategy that has historically delivered attractive long-term returns, albeit with extended periods of underperformance. The last decade illustrates that perfectly. Large-cap growth dominated while small-cap value struggled. That doesn't invalidate the factor approach though.
Instead, it highlights that factors move in and out of favor over long market cycles. It's also why firms such as Dimensional Fund Advisors and Avantis Investors have built much of their investment philosophy around systematic factor investing rather than attempting to predict short-term market leadership.
I consider VBR an excellent introduction to factor investing for investors who want a straightforward, low-cost approach. The fund passively tracks the Morningstar US Small Cap Value Index while charging a low expense ratio of just 0.05%
The portfolio of 840 holdings has virtually no overlap with the S&P 500's mega-cap leaders. Its median market capitalization is approximately $10.5 billion , firmly placing it in the small-cap universe. It also trades at a much lower 18-times price-to-earnings ratio , offering a noticeably cheaper valuation than the broader U.S. market.
Historically, the strategy has rewarded patient investors. Over the past 10 years, VBR has produced a 10.57% annualized total return . That trails the S&P 500 during one of the strongest large-cap growth markets in history, but the current environment illustrates why diversification across factors can matter.
Personally, I wouldn't use VBR as the core of an equity portfolio. Instead, I think it works best as a satellite allocation of roughly 10% to 20% alongside a broad market index fund. The key is maintaining discipline. Small-cap value investing only works if you're willing to stick with it through both the good years and the disappointing ones.
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