Exchange-traded funds are crushing mutual funds thanks to their low fees. And small-cap ETFs are actually beating their indices. This is especially true in the small-cap space, where certain ETFs have no fees.

How so? Well, short-sellers are flocking to small-cap stocks, allowing ETFs to make money by lending out their holdings to shorts. In some cases the fees they’re making off shorts is higher than the expense ratio, pushing the ETF performance above the index performance.

Case in point, two of the top two small-cap ETFs.

The iShares Russell 2000 ETF (NYSE: IWM) is down 13.25% in the last year. Meanwhile, the index it tracks, the Russell 2000, is off 13.43%. The Vanguard Small-Cap ETF (NYSE: VB) is down 11.66% over the last year. Its index, the CRSP Small-Cap Index is down 11.88%.

Granted, it’s not a huge sum, but on that $1 million portfolio you’ve got invested in small-caps, you’re looking at a $1,800 to $2,000 in tracking error ‘profits.’

Long live short sellers.

Short sellers and tracking errors don’t make the list of Six Small-Cap Laws, but may well be worth penciling in. This is part of our increased small-cap coverage. After all, Ibbotson shows that small-caps posted an average return of 12%+ from 1927 to 2007 — $1,000 in small-caps in 1925 would equal $16 million today, compared to the $3 million you’d have by investing in large caps. Want to be apart of what we’re doing? Sign up for the FREE SMALL-CAPS NEWSLETTER.

ETF flows by domicile