Small-cap exchange-traded funds (ETFs) struggled to start 2017, but these ETFs have recently shown some signs of shaking off that lethargy. For investors that remain leery of smaller stocks, it is possible to reduce risk in this asset class with dividend payers. The WisdomTree U.S. SmallCap Quality Dividend Growth Fund (DGRS) offers an avenue to small-cap stocks with impressive dividend prospects. DGRS, which currently resides just below record highs, is up 19.5 percent over the past year.
DGRS is one of a growing number of smart beta options in the world of small-cap ETFs. The ETF’s index embodies the idea of weighting stocks by fundamental metrics, not market capitalization. The WisdomTree U.S. SmallCap Quality Dividend Growth Index holds companies based on combined growth and quality metrics. (See also: 4 Small-Cap Core ETFs for Bull and Bear Markets.)
“The growth factor ranking is based on long-term earnings growth expectations, while the quality factor ranking is based on three-year historical averages for return on equity and return on assets. The index is dividend weighted annually to reflect the proportionate share of the aggregate cash dividends each component company is projected to pay in the coming year, based on the most recently declared dividend per share,” according to WisdomTree.
DGRS holds nearly 260 stocks, nearly five times the number found in a competing small-cap dividend ETF that uses a minimum dividend increase as part of its stock selection criteria. “The WisdomTree U.S. SmallCap Quality Dividend Growth Index had 257 constituents as of March 31, 2017,” said WisdomTree in a recent note. “The reason for the relative broadness of exposure is that the forward-looking earnings growth expectations combined with return on equity and return on assets create a logical framework upon which potential future dividend growth may be built.” (See also: 5 Best Smart Beta ETFs That Pay Dividends.)
DGRS allocates over 48 percent of its weight to industrial and consumer discretionary stocks. By comparison, the Russell 2000 Index devotes less than 27 percent of its weight to those two sectors. Historical data indicate that small-cap dividend-paying stocks usually outperform their non-dividend counterparts over the long term while being less volatile. DGRS is a couple of months shy of its fourth birthday, and the ETF has returned more than 48 percent since coming to market. Including paid dividends, this small-cap dividend ETF has topped the Russell 2000 by 470 basis points since coming to market while being slightly less volatile than the small-cap benchmark. (See also: Top 3 Small-Cap ETFs for 2017.)