Small-cap exchange traded funds have betrayed their reputations as credible beneficiaries of the stronger U.S. dollar. The iShares Russell 2000 ETF (NYSE:IWM) and the iShares Core S&P Small-Cap ETF (NYSE:IJR) are up an average of just 1.5 percent year-to-date while the S&P 500 is higher by 2.2 percent.
The theory is that smaller companies should thrive when the dollar rises because these companies generate the bulk of their revenue within the confines of U.S. borders. Slack performances turned in by small-cap ETFs indicate smaller stocks have been vulnerable to rising real interest rates, perhaps the biggest contributor to dollar strength.
Continue Reading Below
There are no guarantees that small-caps will remain unresponsive to the strong dollar and if the situation reverses, investors should be prepared. The WisdomTree SmallCap Dividend Fund (NYSE:DES) is an ETF that helps with that preparation. DES tracks the fundamentally-weighted WisdomTree SmallCap Dividend Index (WTSDI).
Related Link: A Weird Political Catalyst Could Spark Brazil ETFs
Of WisdomTree's dozens of equity benchmarks, only the WisdomTree Strong Dollar U.S. Equity Index (WTUSSD) sees its components generate a higher percentage of revenue within the US than the WisdomTree SmallCap Dividend Index. WisdomTree's strong dollar index is the benchmark for the new WisdomTree Strong Dollar U.S. Equity Fund (NYSE: USSD), an ETF dedicated to companies positioned tobe strong dollar winners.
USSD member firms generate 96 percent of their revenue inside the US while DES holdings check in at 81 percent of revenue generated on a domestic basis, which is slightly ahead of the 80 percent average for S&P SmallCap 600 member firms, according to a WisdomTree note out Monday.
Small- and Mid-Cap Indexes typically generate a higher percentage of their revenues from their domestic economies than do large-cap indexes. Another way to potentially steer around the negative earnings impact from a strong dollar would be to focus on small- and mid-cap companies, which tend to be less reliant on exports to drive revenue, said WisdomTree Research Director Jeremy Schwartz in the note.
DES, which recently turned nine years old, is home to 700 stocks, only of two which command more than 1 percent of the ETF's weight. For a small-cap ETF, DES's distribution yield of 2.6 percent is almost exceptional and 45 basis points above where 10-year Treasury yields reside at this writing.
DES allocates a quarter of its weight to financial services stocks, which explains the ETF's tepid year-to-date showing. Investors have fretted over the impact a flatter yield curve will have on small-cap financials, a fear that has dragged on the likes of DES and IWM.
Still, DES does offer some sector-level perks. For example, the ETF's healthcare allocation is just 4.8 percent, indicating a retrenchment in biotech stocks would basically be a non-event for the fund. Additionally, small-cap energy stocks have been among that downtrodden sector's worst offenders, but that group is less than 3.8 percent of DES's weight. Only telecom stocks garner a smaller weight in the fund.
2015 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.