Keeping It Fundamental With Small-Cap ETFs

Framed as strong dollar plays, major small-cap indexes have disappointed this year with the Russell 2000 and the S&P SmallCap 600 posting an average year-to-date loss of almost 4.4 percent. Some fundamentally-weighted small-cap exchange traded funds have performed even worse than traditional benchmarks, but laggard performances by the fundamental ETFs could be opening the door to opportunity with these funds.

The WisdomTree SmallCap Earnings Fund EES and the WisdomTree SmallCap Dividend Fund DES are two prime fundamentally-weighted small-cap ETFs for investors to consider because even these ETFs have lagged their traditionally-weighted peers this year, the long-term track records of DES and EES are compelling.

Advantages

Before getting involved, investors should understand the advantages offered by DES and EES and exactly what makes these ETFs tick.

“One of the most important elements of a fundamental index is the annual rebalance process, where the index screens the eligible universe and then weights those securities based on their fundamentals. In essence, the process takes a detailed look at the relationship between the underlying fundamentals and price performance,” said WisdomTree in a note out Thursday.

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EES, home to nearly $390 million in assets under management, tracks an index that holds almost 960 stocks. What is most important about that index is that it only includes companies that have displayed profitability over the previous four fiscal quarters. Often times, small-cap investors are willing to sacrifice a company's profitability for its growth prospects, but EES does not subscribe to that line of thinking.

What investors need to know is that the index EES tracks and the ETF itself have been around since February 2007 and over that time, the WisdomTree index has delivered a higher Sharpe Ratio, meaning superior risk-adjusted returns, than the Russell 2000, according to WisdomTree data.

The $1.1 billion DES, as its name implies, captures a concept that is usually foreign in standard small-cap ETFs. That being a dependable dividend stream. DES is not a yield-based ETF. Rather, its roughly 700 holdings are weighted based on cash dividends paid.

As is seen with EES, since inception, the index DES tracks has delivered better average annual performance with a higher Sharpe Ratio than the Russell 2000.

“WisdomTree believes that the more inefficient the market, the greater the potential for fundamentally weighted indexes to outperform market capitalization-weighted indexes. Therefore, it has come as no surprise to us that, since their inception, WisdomTree’s fundamentally weighted Indexes have produced some of the greatest outperformance compared to their cap-weighted peers in the small-capitalization size segments,” said the issuer.