A Surprising Thrill With A Small-Cap ETF

Small-cap exchange traded are in rally mode this year and some of the more conservative strategies in this market segment are participating in that upside. That includes dividend-focused ETFs.

Just look at the WisdomTree U.S. SmallCap Dividend Fund DES, which is higher by nearly 17 percent year-to-date.

What Happened

Small-cap ETFs were drubbed in the fourth quarter and entered bear markets before their large-cap counterparts. During that period, small-cap dividend funds faltered as well, but many were less volatile than their traditional rivals.

Last December, “when perceptions and sentiment were stressed and in risk-off mode, the Russell 2000 Index dropped farther than the S&P 500 Index,” said WisdomTree in a note out Monday. “During the risk-on period in January 2019, the Russell 2000 Index outperformed the S&P 500 Index, showcasing the capability of small caps to respond quickly in a positive direction as conditions change.”

Last year, DES was 280 basis points less volatile than the Russell 2000 Index. In each year from 2013 through 2018, the small-cap dividend fund was less volatile than the Russell 2000. (Disclosure: The author owns shares of DES.)

Why It's Important

DES yields 3.28 percent, or 202 basis points above the dividend yield on the Russell 2000. Year to date, DES is performing inline with the Russell 2000 Value Index with a dividend yield that's more than 130 basis points higher. From 2007 through 2018, DES outperformed the Russell 2000 Value Index in all but three years.

“The WisdomTree U.S. SmallCap Dividend Index includes only dividend-paying companies and weights those firms on the cash dividends they pay,” said WisdomTree. “Valuation risk is mitigated, as companies with more established businesses tend to commit to paying regular dividends.”

What's Next

The value comparison is credible because DES's multiples historically reside below those of the Russell 2000, a scenario that is showing itself again this year.

“At the end of 2018, the WisdomTree U.S. SmallCap Earnings Index indicated a forward P/E ratio that was more than 54% less expensive than the Russell 2000 Index,” according to WisdomTree. “The WisdomTree U.S. SmallCap Earnings Index has been in live calculation since February 1, 2007, and has never ended a year with a discount like it has now. This tells us that, if there are to be late-cycle rallies and a bit of multiple expansion in U.S. small caps, this strategy may have the potential to capitalize.”

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