A Dividend ETF Gets Aggressive With Interest Rate Protection

Conventional wisdom often dictates that some dividend stocks and sectors prized for their payouts are vulnerable during Federal Reserve tightening cycles. Conversely, some market participants believe small-cap stocks offer upside potential during tightening cycles, as smaller companies are more exposed to the domestic economy than international markets.

That is probably one of the reasons behind the recent rally in small-cap stocks and exchange traded funds, but where do the aforementioned scenarios leave small-cap dividend ETFs? One issuer is taking a proactive approach to the current interest rate environment.

What Happened

Kevin O'Leary's O'Shares ETF Investments recently consulted with index provider FTSE Russell to give the O’Shares FTSE Russell Small Cap Quality Dividend ETF OUSM a new, less-rate-sensitive look.

OUSM has participated in the small-cap rally, gaining about 3 percent this month, but its new look is particularly noteworthy if the Federal Reserve opts for more interest rate hikes in the second half of 2018.

Why It's Important

FTSE Russell made some tweaks to OUSM's underlying index.

The result is the new FTSE USA Small Cap ex Real Estate 2Qual/Vol/Yield 3% Capped Factor Index — it excludes real estate investment trusts, which had been a 21-percent allocation,” the index provider said. “This change removes REITs and reduces the number of constituent holdings from 310 to 224, increasing the weight of other growth industries in the index such as health care, financials and technology.”

OUSM now has no exposure to real estate stocks and its combined weight to the rate-sensitive consumer staples, telecommunications and utilities sectors is just under 12 percent.

What's Next

The elimination of real estate stocks and the relatively low exposure to other rate-sensitive sectors jibes with OUSM's objective of being a quality dividend play rather than a high-dividend fund.

“Speaking with our investors and observing the direction of US equity markets, we became concerned about the impact of REITs in the O’Shares FTSE Russell US Small Cap Quality Dividend ETF,” said O'Shares founder O'Leary. “A combination of rising interest rates and slowing economic growth has impacted this area and we thought the ETF could benefit from an underlying index that was free of this asset class and more diversified in other sectors.”

OUSM is now more cyclically positioned at the sector level, with the industrial and financial services sectors combining for over 42 percent of the fund's weight.

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