How To Play Small-Caps For The Long Term

Investors typically favor small-cap stocks for exciting growth prospects. The trade-off is that smaller companies are, historically, more volatile than their large-cap counterparts, making it difficult for skittish investors to embrace small caps.

Some small-cap exchange traded funds can smooth out some of the volatility associated with the asset class while not skimping on long-term total returns.

What Happened

The O’Shares FTSE Russell Small Cap Quality Dividend ETF OUSM is one such ETF. The $133.48 million OUSM tracks the FTSE USA Small Cap ex Real Estate 2Qual/Vol/Yield 3% Capped Factor Index.

OUSM's underlying index “is designed to reflect the performance of publicly-listed small-capitalization dividend-paying issuers in the United States exhibiting high quality, low volatility and high dividend yields, as determined by FTSE Russell,” according to O'Shares. “The quality and low volatility factors are designed to reduce exposure to high dividend equities that have experienced large price declines, as may occur with some dividend investing strategies.”

Why It's Important

Over the long term, small-cap dividend payers outperform smaller stocks that aren't dividend payers and do so by significant margins. Over the past 20 years, the Russell 2000 Dividend Growth Index produced average annualized returns of 12.4 percent compared to 10 percent for the Russell 2000 Index, according to O'Shares data.

For its part, OUSM has returned nearly 18 percent since its inception 22 months ago. Small-cap dividend ETFs, such as OUSM, also offer more on the yield front than their non-dividend rivals. OUSM's trailing 12-month dividend yield of 1.93 percent may not sound like much, but it's higher than the average 12-month dividend yield of 1.15 percent on the Russell 2000 and the S&P SmallCap 600 Index. Several of OUSM's top 10 holdings have dividend yields north of 3 percent.

What's Next

Even with its status as a dividend ETF, OUSM has a healthy weight to small-cap technology stocks at 19.37 percent, making that the fund's second-largest sector allocation. OUSM's technology exposure is significantly higher than that of the Russell 2000 and the S&P SmallCap 600 Index.

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