As measured by the Russell 2000 Index, small-caps have barely offered any upside this year. That indicates the asset class hasn’t been worth the risk relative to large-caps. Add to that the fact that some traditional measures of small-cap value equities are in the red.
Put it all together and it’s not surprising that market participants aren’t gravitating to small-cap value. However, that might be the wrong approach. That’s because market history confirms some of the best opportunities often prove to be contrarian ideas. That could be one reason to evaluate ETFs like the ALPS O’Shares US Small-Cap Quality Dividend ETF (OUSM).
OUSM’s quality overlay brings an element of steadiness to often volatile smaller stocks. That is paying off for investors this year. That’s because the ALPS ETF is easily outperforming both standard small-cap benchmarks and related value indexes and funds.
Small-Cap ETF OUSM Offers Value
OUSM isn’t a dedicated value fund. Rather, the ETF’s factors of emphasis are dividends, low volatility, and quality. However, each of those factors often unearth stocks with the value designation, indicating OUSM could be a beneficiary of the size/value combination. Indeed, there’s no denying that small-cap equities are currently trading at depressed multiples.
“The ratio of the Russell 1000 index’s price-to-sales multiple to the Russell 2000’s P/S stands at about 2.1. That’s high compared with historical valuations. The average ratio since 2007’s first quarter has been 1.57,” reported Larry Rothman for Pensions & Investments.
As Rothman wrote, some of the valuation differences between large- and small-cap benchmarks stems from the former often being heavily allocated to tech. And the latter tilts to more cyclical sectors that often fall in the value sleeve. That’s pertinent when evaluating OUSM’s value credentials. That’s because the ETF allocates nearly two-thirds of its weight to consumer discretionary, financial services, and industrial stocks.
Another point in favor of OUSM is the fact that small-caps would likely be more positively correlated to an interest rate cut by the Federal Reserve than larger stocks. Citi strategists articulated as much in a recent report that lower rates could lead to reduced interest expenses for smaller firms. Less capital devoted to tending to debt could be helpful in terms of juicing earnings for small- and midcap firms.
“At work is the trade-off between interest income on cash relative to interest expense on floating- and fixed-rate debt,” according to Citi.
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