Up almost 10% this year, the ProShares Russell 2000 Dividend Growers ETF (CBOE: SMDV) has been a steady performer among small-cap ETFs this year while providing an income-rich option with less volatility than traditional small-cap strategies.

SMDV, a dividend spin on the Russell 2000, the benchmark U.S. small-cap index, tracks the Russell 2000 Dividend Growth Index, which includes small-cap firms with dividend increase streaks of at least a decade. While small-cap funds, both active and passive, stumbled late last year, the group’s one-year returns remain impressive.

Renewed strength in small-cap financial services stocks could provide a major assist to SMDV as 2019 moves along.

“The S&P Small-Cap 600 Small Cap Index returned 8.3% for the 12 months through March 1 (with dividends reinvested), while its banking industry group returned 4.4%,” reports MarketWatch. “One reason banks have underperformed is that while short-term interest rates have been increasing, long-term rates haven’t moved much higher. This flattening of the yield curve has squeezed banks’ profits.”

Why Financial Services Is Important to SMDV ETF

SMDV allocates 16.85% of its weight to financial services stocks, making that the ETF ‘s third-largest sector weight behind utilities and industrials. After disappointing in 2018, regional bank stocks and ETFs are finally delivering for investors this year.

Related: Quality Factor is Making Investors Take Note in 2019

Higher interest rates would help widen the difference between what banks charge on loans and pay on deposits, which would boost earnings for the financial sector. Regional banks are among the stocks most positively correlated to rising interest rates because higher rates improve net interest margins.

“There is an opportunity for net interest margins (the spread between what banks earn on loans and investments and what they pay for deposits) to widen,” said Jay Kaplan of Royce Funds in an interview with Royce Funds. “The Federal Open Market Committee changed the tone of its policy statement on Jan. 30, indicating it was less likely to continue raising short-term interest rates. This means the increase of banks’ deposit gathering expenses will slow or stop.”

SMDV, which has a five-star Morningstar rating and its underlying index has offered impressive long-term performance relative to traditional small-cap benchmarks. Over the past year, SMDV is up almost 12% while the Russell 2000 is higher by just 2.45%.

For more on core investing strategies, please visit our Core ETF Channel.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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