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A Quality Approach to Small Caps

This article was originally published on ETFTrends.com.

Small-cap stocks and the corresponding exchange traded funds recently entered bear markets, reminding investors considering this asset class that a quality approach can offer some defense with smaller companies.

The WisdomTree U.S. SmallCap Dividend Growth Fund (DGRS) helps investors focus on quality small-cap names with the advantages of dividend growth.

DGRS tracks the WisdomTree U.S. SmallCap Dividend Growth Index, which is weighed by fundamental factors such as growth expectations, return on equity and return on assets, according to WisdomTree.

“The WisdomTree U.S. SmallCap Quality Dividend Growth Index is a more selective cut of small caps, containing 272 constituents. The Index screens for companies with attractive growth and profitability characteristics on an annual basis, also in December,” said WisdomTree in a recent note.

Slice And Dice

The refined approach to small caps used by DGRS offers other advantages, including harnessing companies with strong balance sheets.

“By slicing the universe of U.S. small caps in these different ways, the fundamental exposures that result for these Indexes are considerably different from the Russell 2000. The WisdomTree U.S. SmallCap Quality Dividend Growth Index offers an interest-coverage ratio of over twice that of the Russell 2000, while at a significant valuation discount based on price-to-earnings,” according to WisdomTree.

While the quality factor often trades at a premium to value, quality stocks are usually less volatile than traditional broad market strategies, indicating some overlap with the low volatility factor.

Valuing high quality value is particularly important as bull markets enter their waning stages, as some market observers believe the current bull market is doing. In the early stages of bull markets, lower quality companies see their shares soar. However, as the bull matures, investors often exhibit a preference for higher quality fare with more compelling valuations.

“Typically, investors would be required to pay a significant premium to own more stable, quality companies. Uniquely for both the WisdomTree Indexes, higher quality metrics are offered at a significant discount to the Russell 2000,” said WisdomTree.

For more information on the smart beta strategy, visit our smart beta category.