A Size Advantage For This Emerging Markets ETF

A cursory glance reveals this has been a good year for small caps. The Russell 2000 Index and the S&P SmallCap 600 Index are up an average of 10.7 percent year-to-date.

As has been previously noted in this space, adding the dividend element to small stocks is proving even more rewarding in 2016. How about emerging markets? The combination of emerging markets dividends and small caps is proving particularly potent this year. So much so that the WisdomTree Emerging Markets High Dividend Fund (NYSE:DGS) is leaving the aforementioned U.S. small-cap benchmarks in the dust.

DGS is up 22 percent year-to-date with annualized volatility of 20.7 percent, which is not much more than the Russell 2000 or S&P SmallCap 600, meaning DGS is delivering superior risk-adjusted returns. Not only that, but DGS is topping large-cap emerging markets indexes. DGS is ahead of the MSCI Emerging Markets index by 650 basis points this year while being 370 basis points less volatile.

DGS's holdings include the 10 percent of the WisdomTree Emerging Markets Dividend Index with the smallest market caps. The ETF's constituents are then weighted by paid dividends, an approach that helps juice yield, and, potentially, returns.

This approach typically raises the dividend yield on the underlying Index, and can give the WisdomTree strategy an advantage on relative valuation compared to the broader market. "As of July 31, the WisdomTree Emerging Markets SmallCap Dividend Index exhibited a trailing dividend yield of 4.1% compared to the 2.7% of the MSCI Emerging Markets Index. And the price-to-earnings ratio (P/E) on the WisdomTree Emerging Markets SmallCap Dividend Index was less than 13, when the S&P 500 was trading at 20 times trailing earnings, said WisdomTree Chief Investment Strategist Luciano Siracusano in a note Monday.

DGS, which was one of 150 ETFs to hit 52-week highs on Monday, allocates a combined 52.5 percent of its geographic weight to Taiwan, China and Brazil. At about 8.9 percent, Thailand is the ETF's fourth-largest country allocation, representing an overweight to Thai stocks relative to the MSCI Emerging Markets Index.

DGS also trumps its U.S. equivalents on yield. The ETF's underlying index yields 4 percent, more than triple the 1.46 percent found on the Russell 2000.

Although emerging market small-cap dividend payers have shown relative strength compared to the broader EM universe in 2016, the truth is, we have seen small-cap dividend payers outperform the MSCI Emerging Markets Index pretty consistently since we launched the strategy back in 2007, adds Siracusano.