Large-cap stocks, particularly those with the growth label, are usually headline grabbers. However, small-cap equities and the related exchange traded funds have recently been making their presence felt despite the fact that the widely-followed Russell 2000 Index is lower by 4.80% over the past month. The reasoning behind the recent flurry of attention by small-cap equities and ETFs is easy to understand because it boils down to one word: Value. As in, small-caps are currently steeply discounted compared to large-cap peers. As in, historically discounted.
“Over the past 20 years smaller US companies have rarely been so cheap relative to large caps as they are today,” according to Schroders. “They are pricing in a lot of bad news. Indeed, US smaller companies trade at similar valuations to markets outside the US for the first time in years – offering investors a route into the US economy without paying a premium.”
Yes, it’s certainly possible that small-cap ETFs will continue flailing over the near-term and valuations could remain depressed for some time. Still, risk-tolerant investors may find some of the following funds to be appealing avenues for tapping into a possible small-cap resurgence.
WisdomTree U.S. SmallCap Quality Dividend Growth Fund (DGRS)
As it name implies, the WisdomTree U.S. SmallCap Quality Dividend Growth Fund (DGRS) is a small-cap dividend ETF, of which there aren’t many on the market. That’s the result of small-caps long being viewed not as a prime destination for equity income. Recent years have brought some positive change on that front.
DGRS’s marriage of quality and income has enabled the ETF to outpace traditional small-cap indexes over the long haul while displaying superior volatility traits relative to those benchmarks. In the current environment, DGRS is pertinent not only because many of its holdings are profitable, but also because those companies aren’t heavily indebted .
“Higher interest expenses are also starting to consume greater portions of trailing earnings before interest and taxes (EBIT) and revenues within the S&P 600 and Russell 2000. Larger companies who tap the bond markets for their loans are able to extend maturities like the typical mortgage refinancer and have been better fortified against these rising cost,” noted WisdomTree’s Brian Manby.
Dimensional US SmallCap Value ETF (DFSV)
The Dimensional US Small Cap Value ETF (DFSV) is one of a variety of mutual fund-to-ETF conversions that have enable Dimensional Fund Advisors (DFA) to become a $100 billion+ ETF issuer and in short order at that. More importantly, small-cap value has historically been a potent combination. It’s also one that’s relevant today owing to the aforementioned historically low multiples on smaller stocks.
The $1.9 billion DFSV attempts to beat the Russell 2000 Value Index and holds 1,019 stocks, more than 44% of which hail from the financial services and industrial sectors. Importantly, many DFSV member firms are profitable.
“Profitable companies in the Russell 2000 Index, making up roughly two-thirds of the index, currently trade at a –33% discount to the S&P 500, relative to the long-term average premium of 2%,” according to Goldman Sachs Asset Management (GSAM). “In our view, improving U.S. growth sentiment, alongside historically low relative valuations of cash-flow-positive companies, make small-cap equities an attractive alternative to large-cap peers trading at already full valuations.”
Nationwide Russell 2000 Risk-Managed Income ETF (NTKI)
The Nationwide Russell 2000 Risk-Managed Income ETF offers investors two traits that are rare with small-cap equities: Extremely high levels of income and a reduced volatility profile. Actively managed, NTKI generates income by selling options on the Russell 2000 Index.
The ETF’s downside protection comes by of purchasing put options on that index. Basically, NTKI is an options collar strategy in ETF form.
The fund turns two years old next month and sported a tempting distribution yield of 7.12% at the end of the third quarter – far higher than the dividend yields found on basic small-cap ETFs.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.