Market Overview

An Enticing Small-Cap ETF

An Enticing Small-Cap ETF

May was a brutal month for stocks, with the S&P 500 losing 5.67 percent. Small caps were worse with the Russell 2000 Index dropping almost 7 percent for the month. The WisdomTree U.S. SmallCap Dividend Fund (NYSE: DES) was not immune from that negativity as the dividend sank 8.20 percent in May.

What Happened

That is not a ringing endorsement of DES, one of the original small-cap dividend exchange traded funds, but that May turbulence could bring opportunity with a fund that has historically outperformed non-dividend small-cap strategies.

DES, which turns 13 years old next month, tracks the fundamentally-weighted WisdomTree U.S. SmallCap Dividend Index. That benchmark's holdings are weighted by cash dividends paid.

“This portfolio targets dividend payers without incurring too much risk,” said Morningstar in a recent note. “Although the fund doesn’t screen its holdings for profitability or dividend sustainability, a few dividend cuts across its portfolio shouldn’t significantly affect its performance because it is broadly diversified and skews toward larger, more-stable names in the small-value Morningstar Category.”

Why It's Important

DES holds nearly 700 stocks and has a distribution yield of 2.81 percent, more than double the comparable yield on the Russell 2000. The largest weight assigned to any of the fund's holdings is just 1.36 percent.

“Its broad reach limits its exposure to firm-specific risk and the highest-yielding stocks, which are more likely to cut their dividends than their lower-yielding counterparts,” said Morningstar. “At the end of April 2019, it had greater exposure to consumer discretionary, real estate and utility stocks than the Russell 2000 Value Index, and less exposure to the healthcare and information technology sectors.”

DES allocates just over 46 percent of its combined weight to the industrial, consumer discretionary and real estate sectors.

What's Next

Past performance is not a guarantee of future returns, but DES has a tradition of besting rival small-cap value strategies.

“From its launch in June 2006 through April 2019, the strategy has topped the small-value category average and the Russell 2000 Value Index by 1.2 and 1.0 percentage points annually, respectively, with similar risk,” according to Morningstar. “The fund’s favorable stock exposure within the energy and consumer discretionary sectors contributed to most to its outperformance.”

The research firm has a Bronze rating on the $1.9 billion DES.

Disclosure: The author owns shares of DES.

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