With the Dow regularly dropping triple digits in a day and the market sometimes seemingly headed for an all-out panic, probably about the last thing on many investors’ minds is what to buy next. At this point, they’re especially wary of small-cap stocks, which long outperformed, but have recently been among the fastest-plunging asset classes.

#-ad_banner-#However, because the pullback in small-caps started several months before the broader market began correcting, it’s quite possible smaller firms could lead us out of the current storm. Exactly when, of course, is hard to predict. But with the Russell 2000 index of small-cap stocks already well into correction territory, such stocks may be in a position to begin recovering soon.

So I’ll ask the question that’s probably furthest from many investors’ minds: What should you buy to play a small-cap rebound?

Since individual stocks can be particularly risky in rough markets like this one, I’d posit that the best way to take advantage of a broad small-cap rally is mainly through a diversified fund. The one I suggest has several standout characteristics, like a great long-term record. It has beaten the market by more than 5% per year and the Russell 2000 by 1% a year for the past 15 years, returning 10% annually during that period.

Now, DFA U.S. Small Cap (NYSE: DFSTX) didn’t compile this impressive record by being mostly mediocre with a couple unusually great years thrown in, like many funds. Rather, it has consistently beaten most of its peers in the small-blend category in the short- and long-term — like during the past five years, when it bested 82% of all other small-blend funds.

Probably the fund’s most potent asset over the years has been its management team, which is highly experienced, yet still plenty youthful. So it could be many years before shareholders have to worry about performance issues related to a changing of the guard. The current lead portfolio manager, Stephen Clark, has been with DFA since 2001 and in charge of DFSTX since 2008.

Of the four other managers currently helping to run DFSTX, most haven’t been with the fund all that long, only about two years apiece. However, they’re all long-term DFA employees, with service records ranging from nine-to-twenty years.

Under its management team, the fund offers broad small-cap stock exposure like an index. But as Morningstar points out, it has one key advantage — it’s not required to track an index.

Management is therefore free to do things like wait for more favorable pricing on stocks, substitute those that are better values and hold onto great stocks an index fund might have to sell in order to match index composition. Not having to sell just to track an index can be a major plus since studies have shown that stocks often go on to outperform after they leave an index, Morningstar notes.

Because DFSTX can, and often does, keep outperformers longer, the stocks in the fund have a somewhat larger average market value of nearly $1.5 billion, versus about $1.37 billion for the Russell 2000. The following two tables show DFSTX’s top five holdings and sector allocations.

Whereas many domestically-focused small-cap funds also have substantial exposure to foreign stocks, DFSTX has virtually none. Ninety-nine percent of its holdings are U.S. stocks, with the remaining 1% representing miniscule positions in Latin America, Western Europe and Asia.

The fund has an expense ratio of 0.37%, which is very cheap but still around ten basis points more than what the best small-cap index mutual funds charge. The difference in dollar terms is negligible, though, and DFSTX is well worth the slightly higher cost considering its potential to outperform over the long haul.

While DFSTX fluctuates about as much as the typical small-blend mutual fund, it can be a lot more volatile than the broader stock market. For instance, it has been about 40% more volatile than the S&P 500 during the past three years.

Risks to Consider: With nearly all its assets in U.S.-based firms, DFSTX is highly exposed to the risks of a rising dollar. As you probably know, the dollar has strengthened a lot lately, and this can reduce the value of profits earned overseas. (Less favorable exchange rates result in foreign profits being converted to fewer dollars.) Many of the companies DFSTX owns are susceptible to this, like top holding Spirit Airlines (NASDAQ: SAVE), which has significant operations in Latin America and the Caribbean.

Action to Take –> With its diversified portfolio, DFA U.S. Small Cap is an excellent way to play a small-cap rebound and arguably the best small-cap fund to own for the long-term. The fact that it’s only available through fee-only financial advisors could be viewed as an impediment for do-it-yourself investors. It doesn’t have to be, though, since people ought to have an advisor anyway for other areas of personal finance even if they prefer to manage their own investments.

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