How To Get A Small-Cap Buffer

Historical data confirm small-cap stocks and exchange traded funds are typically more volatile than large-cap equivalents.

Last year, the annualized volatility for the S&P 500 was 17 percent while the average annualized volatility for the Russell 2000 Index and the S&P SmallCap 600 Index, two of the most widely followed small-cap benchmarks, was 17.8 percent.

What Happened

An ideal way of muting some of the turbulence associated with smaller stocks is to focus on dividends, particularly small-cap names with track records of consistent dividend increases.

The ProShares Russell 2000 Dividend Growers ETF SMDV is an efficient avenue for investors looking for small-cap dividend payers. SMDV, which turns four years old next month, follows the Russell 2000 Dividend Growth Index, the dividend growth offshoot of the Russell 2000.

SMDV's underlying index requires member firms to have dividend increase streaks of at least a decade.

Why It's Important

Last year wasn't a good year for small caps, but SMDV proved the advantages of small-cap dividend growth. The fund lost 0.6 percent on the year, which was significantly less worse than the 11.1 percent shed by the Russell 2000 Index. SMDV was also significantly less volatile than the small-cap benchmark with annualized volatility of just 13.9 percent.

“US small-cap stocks with a track record of strong dividend growth had higher returns and less volatility versus the broad universe of US small-caps in 2018, in line with a similar trend demonstrated over the last decade,” said FTSE Russell in a recent note. “And, notably, this outperformance accelerated in fourth quarter during a particularly volatile period for US equities in general and US small-caps in particular.”

While the fourth quarter was dismal for small caps, SMDV's underlying index performed much less poorly than the Russell 2000.

“And, in the fourth quarter of 2018, when the Russell 2000 Index lost 20.2% the Russell 2000 Dividend Growth Index was down just 8%,” according to FTSE Russell.

What's Next

SMDV's potential to endure volatile environments for small-cap stocks isn't new. Going back 20 years, SMDV's underlying index had annualized volatility that was 450 basis points below the Russell 2000 while providing 4.20 percent of excess return, according to the index provider.

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