Symposium: Navigate Small-Cap Rate Pressures With Free Cash Flow

Today’s elevated interest rate environment is creating a persistent headwind for small-cap equities. Heavy debt loads and unprofitable business models frequently drag down broad, small-cap benchmarks. The antidote to this? Free cash flow (FCF).During a recent TMX VettaFi Market Outlook Symposium Lance Humphrey, head of portfolio management at Victory Capital, outlined how anchoring equity selection in FCF systematically insulates small-cap portfolios while bridging value and growth across market cycles.Key Takeaways Self-financing small-caps: Free cash flow screens eliminate the roughly 40% of unprofitable companies in the Russell 2000, insulating small-cap allocations from debt-servicing pressures during elevated rate regimes. Bridging growth and value: Pairing attractive FCF yield with an explicit screen that removes slow-growing firms prevents value traps while maintaining upside participation. Cross-cap modernization: The same rules-based cash-flow discipline powers both the VictoryShares Small Cap Free Cash Flow ETF (SFLO ) and its large-cap counterpart, the VictoryShares Free Cash Flow ETF (VFLO B+). See More: Why Choose Free Cash Flow Over Other Accounting Metrics?Insulating Small-Caps With SFLOHigh borrowing costs disproportionately penalize smaller companies that rely on external debt markets to fund their operations. FCF, operating cash flow minus capital expenditures, directly identifies businesses capable of funding their own expansion. “What is free cash flow? That means you have cash left over after paying all of your bills,” Humphrey explained. “You’re not as reliant on debt markets because you’re self-financing with your own internal cash flow.” Roughly 40% of the Russell 2000 Index is unprofitable, leaving passive small-cap investors acutely exposed to rate pressures. SFLO addresses this vulnerability by building a 200-stock portfolio where every constituent is profitable and generating positive FCF at rebalance. “When we looked back over the last 25 years of the index, we found that SFLO outperforms the Russell 2000 by more when interest rates are rising than when they’re falling,” Humphrey said.Pairing Value and Growth Without TrapsBeyond rate insulation, Victory Capital’s methodology solves a core flaw in traditional value investing: buying cheap companies whose underlying businesses are deteriorating. Instead of viewing value in isolation, the framework pairs attractive FCF yield with a growth filter that removes companies with the weakest forward prospects.“One of the pitfalls of so many traditional value strategies is this idea of value traps,” Humphrey said. “This is buying companies that appear to be attractively valued, but they might be companies in decline. One thing that’s unique about the Victory Capital free cash flow products is that we incorporate growth into the equation. The way we do that is not by targeting companies with high growth. It’s by removing companies with slow growth.”Extending FCF Discipline to Large-Caps: VFLOWhile small-caps have been garnering more attention this year, large-caps continue to remain at the forefront. 64% of webinar respondents chose large-cap value during the symposium when asked which investment style appeals to them heading into the final months of 2026. That said, a modernized FCF lens extends seamlessly into large-cap equities via VFLO. Traditional benchmarks like the Russell 1000 Value still lean heavily on price-to-book ratios designed decades ago for asset-heavy industrial giants. In an economy driven by intangible assets and heavy AI capital expenditures, FCF yield serves as a far more adaptable valuation metric. Narrowing the large-cap universe to 50 cash-generative companies (while excluding financials and real estate, where FCF is less applicable), VFLO avoids static sector tilts toward financials and utilities. “What we’re finding is advisors oftentimes pair VFLO with an active manager because there’s a lot of complementary elements to it,” Humphrey said. By uniting cash-flow valuation with an explicit growth screen, SFLO and VFLO give allocators complementary, rules-based tools to navigate shifting rate regimes and style rotations across market caps. For more news, information, and analysis, visit the Market Outlooks Content Hub. VettaFi LLC (“VettaFi”) is the index provider for VFLO and SFLO, for which it receives an index licensing fee. However, VFLO and SFLO are not issued, sponsored, endorsed, or sold by VettaFi, and VettaFi has no obligation or liability in connection with the issuance, administration, marketing, or trading of VFLO and SFLO.