This small-cap fund is outperforming the Russell 2000. Here's its strategy.

The may have a profitability problem.

Despite a 10.1% increase in the small-cap index in July, it has decreased by approximately 4% in August, as of Thursday morning.

According to Paul Baiocchi of ALPS, the index's volatile moves can be attributed to the overall composition of the index, with an estimate from Apollo Global indicating that 40% of those companies have negative earnings.

The firm's chief ETF strategist stated on CNBC's "ETF Edge" that investors have accepted the fact that being in the Russell 2000 means they will have to endure both good and bad outcomes.

Baiocchi advises investors to prioritize quality companies by considering more selective exchange-traded funds, such as his firm's.

""Quality companies that pay and grow their dividends, with less volatility than their peers, are the ideal choice for advisors and investors seeking to allocate funds to a lagging category," he stated."

The fund has a profitability screen and only 107 stocks, which is a small fraction of the Russell 2000. Its top three holdings are , and , each with a roughly 2% weighting in the fund, according to FactSet.

Despite a 1.5% decline in small-cap fund shares month to date, the fund has outperformed the Russell by more than 2 percentage points.