Where Small-Caps Are Dynamite

Sure, U.S. small-cap stocks and the related exchange-traded funds have recently been resurgent. Give the widely followed Russell 2000 Index some credit for jumping more than 4 percent over the past month to bring its year-to-date gain to almost 11 percent.

An 11 percent year-to-date gain is nice, but it barely scratches the surface of what ex-U.S. small-cap equities have been delivering this year. Importantly, investors have not needed to take on excessive when venturing outside the U.S. for smaller stocks. The comforts of developed Europe have been rewarding as highlighted by the WisdomTree Europe SmallCap Dividend Fund (NYSE:DFE).

Up 28 percent this year, DFE is topping the Russell 2000 by a margin of better than 2-to-1. While DFE's 2017 ascent is undoubtedly impressive, the ETF's run may not be over.

Small-Cap Value

While U.S. small-caps are often viewed as expensive, particularly when measured against domestic large-caps, DFE's universe actually looks attractive on valuation compared to U.S. equivalents.

In comparing the multiple contraction in European small caps to U.S. small caps, as shown by the Russell 2000 Index, it is apparent that U.S. valuations have hardly changed since the beginning of the year despite lackluster returns, said WisdomTree in a recent note. While U.S. small caps may surprise to the upside this fall if Washington delivers on corporate tax reform, from a valuation perspective, Europe offers an attractive discount when comparing the WisdomTree Europe SmallCap Dividend Index to the Russell 2000 Index. The valuation discount is particularly notable despite the WisdomTree Indexs price increase outpacing that of the Russell Index by more than 15 percentage points.

DFE allocates about half its combined weight to the U.K., Sweden and Italy, all markets where small-cap stocks are discounted relative to their U.S. peers.

Levered To Growth

Since the end of the global financial crisis, Europe's economic recovery has move more slowly than that of the U.S. However, particularly in the case of the eurozone, the recovery is gaining momentum, which could signal more upside for cyclically-positioned ETFs like DFE.

As gross domestic product (GDP) steadily increased over the past several quarters, the European Commissions Economic Sentiment Indicator reached a 10-year high and the United Kingdom was able to broadly weather the economic impacts of the Brexit vote, the outperformance of small caps has accelerated in 2017 with a return advantage of more than 700 basis points (bps), said WisdomTree.

DFE's 400 holdings are all dividend payers with the financial ability to maintain, if not grow, those payouts.

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