For decades, risk-tolerant investors searching for added upside and diversification embraced small-cap stocks. Through many of those years, though with added volatility, smaller equities outperformed their larger peers.
However, the outperformance of small-caps has waned in recent years. This has prompted some experts to ponder the risk-adjusted merits of smaller stocks and related ETFs in portfolios. It’s a “yes” or “no” question. And the answer largely depends on an investor’s risk tolerance and the strategy being deployed. With that in mind, the ALPS O’Shares US Small-Cap Quality Dividend ETF (OUSM) is an example of a small-cap ETF that could be appropriate for investors with extended time horizons.
Regardless of market capitalization segment, there is no perfect solution. But when it comes to small-caps, OUSM merits examination. That’s because its inclusion of dividends and low volatility as foundations are unique in the small-cap ETF space.
OUSM Helps Investors Contend With Small-Cap Issues
One of the primary reasons investors have long allocated to small-cap stocks was they hoped those companies would graduate to mid- and large-cap status. Market history is littered with examples of famed corporations going all the way from small- to mega-cap territory. But the reality is that’s happening less and less because companies are remaining private longer.
“For small-cap investors, the worry is that tomorrow’s Microsoft may never be a public small-cap company,” noted Morningstar’s Zachary Evens. “Many of the most promising young companies now choose to stay private for longer, seeking growth capital from private shareholders instead of entering public markets. As a result, much of their growth accrues as a private firm before they’re subject to the scrutiny and regulation that comes with being publicly traded.”
When many of the most well-known unicorns go public, they’re already sporting valuations that put them deep into large-cap territory. That might not directly affect OUSM. But it underscores the ETF’s utility. And that’s because it offers dividends — something newly public firs rarely feature. And those payouts make the fund easier to remain engaged over long holding periods.
Small-Cap Stocks Historically Inexpensive Today
Dividends are also known to reduce volatility — always a consideration with smaller stocks. Plus, small-cap stocks are historically inexpensive today relative to large-cap rivals. Bottom line: OUSM has the potential to reduce risk and its current cost of admission is appealing.
“Small caps are risky. They’ve always been risky, but those risks are amplified by the shifting structure of the market. Still, under the right circumstances, small-cap ETFs can boost returns and improve diversification,” concluded Evens.
For more news, information, and analysis, visit the ETF Building Blocks Channel.
VettaFi LLC (“VettaFi”) is the index provider for OUSM, for which it receives an index licensing fee. However, OUSM is not issued, sponsored, endorsed, or sold by VettaFi, and VettaFi has no obligation or liability in connection with the issuance, administration, marketing, or trading of OUSM.
