Small-Cap Dividend ETFs Offer Dividend Allure, Too

Large-cap U.S. value stocks are usually the first asset class investors look to in search of dependable, sturdy dividends.

However, soaring payouts across all cap spectrums, due in part to today's low interest rate environment, have shown that growth stocks and even small caps can be legitimate avenues of yield and dividend growth for income investors.

Investors that do not want to stock-pick among small caps in the hunt for dividends, but still want exposure to smaller market capitalization names with solid payouts have an increasing number of options among ETFs.

The WisdomTree SmallCap Dividend Fund (NYSE:DES), with a 30-day SEC yield of 2.84 percent, is one of the more established names among U.S.-focused small-cap dividend ETFs. The fund is seven years old and has nearly $796 million in assets under management. Importantly, the WisdomTree SmallCap Dividend Index features a yield that is well above those found on the Russell 2000 Index and the Russell 2000 Value Index.

Proving that dividends do make a difference over longer time horizons, DES is up 40.6 percent with volatility of 22.3 percent over the past two years. The iShares Russell 2000 ETF (NYSE:IWM) is up 30 percent over the same time with volatility of almost 25 percent.

"We believe that the small-cap segment of the dividend-paying market deserves special attention," said WisdomTree Research Director Jeremy Schwartz in a new research note. "While the large-cap space is without question much more competitive, looking to the small-cap space may provide a diversification benefit at what we believe to be an attractive price."

An added advantage of small-cap dividend ETFs is sector diversification. Many large-cap dividend ETFs are heavily allocated to defensive sectors such as consumer staples, telecommunications and utilities. While those sectors have been favored dividend sectors for decades, telecommunications and utilities are sensitive to rising interest rates and none of the three are among the fastest-growing dividend sectors.

Recent dividend growth leadership in the U.S. has come by way of sectors such as financial services, consumer discretionary and technology. Financial services and consumer discretionary are two of the top-three sector weights in DES, combining for 39 percent of the fund's weight. Technology is another 9.7 percent. However, that does not mean small-cap dividend stocks are expensive on valuation.

"The WisdomTree SmallCap Dividend Index that have growth characteristics, also has a lower P/E ratio than the Russell 2000 Index, as well as significantly higher long-term earnings growth expectations. Similar to the large-cap picture, the picture of small caps as of June 30, 2013, makes it difficult to broadly classify dividend stocks as expensive," said Schwartz.

New Kid On The Block Investors looking for added sources of income among small caps recently got another option when the WisdomTree U.S. SmallCap Dividend Growth Fund (NASDAQ:DGRS) debuted last week. DGRS is the small-cap equivalent of the WisdomTree U.S. Dividend Growth Fund (NASDAQ:DGRW), which is already climbing the ranks of worthwhile new ETFs.

Like DES, DGRS is light on defensive sectors. In fact, the new ETF features significantly less exposure to those groups as telecommunications and utilities are nowhere to be found within the new fund. In terms of dividend growth potential, DGRS offers that with an almost 25 percent weight to discretionary names and a 13 percent allocation to technology.

"If the U.S. economy is indeed on track to recovery, Consumer Discretionary can be a very important sector through which to gain exposure," said Schwartz. "The WisdomTree U.S. Small Cap Dividend Growth Index has more than 25% of its exposure in this sector. By contrast, Consumer Staples is a sector that is often the top exposure in many large-cap focused dividend indexes, and this sector receives less than 2% weight in the U.S. SmallCap Dividend Growth Index."

DES and DGRS both have annual fees of 0.38 percent. DES, as do the rest of the WisdomTree's U.S. dividend ETFs, pays a monthly dividend, so it would be reasonable to expect DGRS to follow suit.

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