How To Go Global With Small-Cap ETFs

U.S. investors usually do not have a problem embracing domestic small caps. The size of some small-cap exchange-traded funds confirms as much, but investors are often lightly allocated to ex-U.S. small caps on the notion that if smaller U.S. stocks are volatile, the international equivalents must be much more turbulent.

A Solution And Its Success

The WisdomTree Global SmallCap Dividend Fund GSD offers a solution to that conundrum. Domestic dividend stocks are historically less volatile than their non-dividend counterparts, and the same is often true at the international level. For investors looking to dodge the commitment of an international ETF, GSD allocates over 49 percent of its weight to dividend-paying U.S. small caps.

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GSD's strategy is working. Over the past six months, the ETF is up more than 5 percent, while the Russell 2000 Index is flat during the period.

GSD follows the WisdomTree Global SmallCap Dividend Index. That index weighs companies “based on annual cash dividends paid. Regional weights are set according to the respective float-adjusted market capitalization weights of the universe of dividend and non-dividend payers of the regional allocations to the U.S., developed and emerging market,” according to WisdomTree.

GSD's underlying index yields nearly 3.7 percent, a data point that is impressive, but even more so when considering the ETF's more than 49 percent weight to U.S. stocks and the often anemic yields on major U.S. small-cap benchmarks. For example, the trailing 12-month dividend yield on the Russell 2000 is just 1.46 percent.

GSD's Country Allocations

Commodity-exporting countries, including Australia, Canada and Norway, give GSD some yield kick.

“These commodity-sensitive markets all tend toward relatively high dividend yields, which leads to over-weight positioning in the WisdomTree Global SmallCap Dividend Index versus the MSCI ACWI Index. Combine this with the fact that commodity countries have rallied and those countries’ currencies have also rallied against the U.S. dollar, and you begin to see how these over-weights have helped relative performance,” said WisdomTree in a new note.

In order, Canada, Australia and Norway combine for 11.5 percent of GSD's weight. Japan is the ETF's second-largest country weight after the United States at 11 percent, indicating GSD is levered to theme of rising Japanese shareholder rewards.

Sector Allocations

Financial service stocks account for nearly 26 percent of GSD's weight, but many of the ETF's holdings from that sector are real estate stocks. That means the ETF is favorably exposed to low and negative interest rates in many ex-U.S. developed markets. Industrial and consumer discretionary names combine for 35 percent of GSD's weight.

“We believe the global small-cap dividend payers’ outperformance thus far in 2016 signals that investors should not forget about small caps; global small caps with a dividend focus are currently delivering strongly in a tough equity environment—and are behaving much different from what we’ve seen in global large caps,” added WisdomTree.