Don't Overlook These Small Caps

Many U.S. investors are familiar with and allocated to in some form or fashion to domestic small-cap stocks. International small caps are different story, but investors would do well to consider smaller stocks hailing from ex-US developed markets.

Better yet, investors should add a dividend buffer to international small-cap allocations, an objective the WisdomTree International SmallCap Dividend Fund (NYSE:DLS) fulfills. DLS, which is over 10 years old, follows the dividend-weighted WisdomTree International SmallCap Dividend Index. That benchmark weights companies on the basis of cash dividends paid.

Ten years is a more than adequate track record with which to assess an ETF's merits and with over $1.1 billion in assets under management, DLS is not a small ETF. Still, investors might overlook international small caps while favoring large-cap MSCI EAFE strategies when data suggest that has been a mistake.

Using the MSCI EAFE Index as a proxy for stocks in the developed world, international stock returns have been paltry1.7% per year in U.S dollars over the last 10 years. But international small caps, as measured by the MSCI EAFE Small Cap Index, advanced 4.1% over the same period. Moreover, if one used only dividend-paying international small-cap stocks, as we do in our WisdomTree International SmallCap Dividend Index, the average annual return for the asset class was 5.1% over the past 10 years, more than 3 percentage points ahead of the broader MSCI EAFE Index, according to a recent WisdomTree note by the firm's chief investment strategist, Luciano Siracusano, and investment analyst Christopher Carrano.

Japan, the U.K. and Australia combine for over 55 percent of the geographic lineup in DLS, indicating the dividend ETF can be used as a complement to traditional EAFE exposure.

DLS also offers a significant yield advantage over competing indexes. As of the end of August, the WisdomTree International SmallCap Dividend Index sported a trailing 12-month dividend yield of 4.33 percent, or more than 170 basis points higher than the MSCI EAFE Small-Cap Index. The yield on the WisdomTree International SmallCap Dividend Index was also nearly 100 basis points higher than that on the MSCI EAFE Index at the end of August.

However, because WisdomTree weights by dividends, the WisdomTree International SmallCap Dividend Index typically exhibits a higher dividend yield compared to the MSCI EAFE Index. Ten years later, the real-time results of the strategy confirm our earlier intuition. International small caps, dividend weighted, have outperformed the MSCI EAFE Index for the last 1-, 3-, 5- and 10-year periods, adds WisdomTree.

Over the past three years, DLS has topped the MSCI EAFE Index by a better than 6-to-1margin while being 200 basis points less volatile.