For decades, smaller stocks and value were among the most potent factor combinations. That’s not to say that the combination has delivered bad performances, but as mega-cap growth stocks have been market leaders recently, both small-cap and value stocks have fallen out of favor.
Additionally, data indicate it’s gotten tougher for small-cap value active managers to beat their benchmarks. That doesn’t mean small-cap value is a lost cause, but the current state of affairs with this factor combination confirms investors should consider unique approaches. Enter the ALPS O’Shares US Small-Cap Quality Dividend ETF (OUSM).
OUSM isn’t a dedicated value fund, but it has hallmarks of value. Importantly, the exchange traded fund’s dividend and quality traits have created what could be a better small-cap value mousetrap. Year-to-date, OUSM is beating the S&P SmallCap 600 Value Index by more than 570 basis points, extending a lengthy run of out-performance over that gauge.
OUSM Methodology Works
It’s not just enviable performance confirming the allure of OUSM’s methodology. Some active small-cap value managers are increasingly leaning into quality to bolster the performance of small-cap value funds.
“Amid years of performance headwinds, managers on such funds have adopted somewhat different approaches to improving returns, such as emphasizing quality in their stock screens to avoid buying cheap stocks that get cheaper. Still, it has been a tough slog,” notes Morningstar analyst Gabe Alpert.
It might be wise for those managers to consider small-cap value portfolio construction that more closely resembles that of OUSM. As Alpert points out, the average small-cap value fund was up 12.4% year-to-date as of late November, meaning those funds, many of which have higher fees than OUSM, are badly trailing the ALPS ETF.
The silver lining for small-cap value is that the group’s recent woes aren’t attributable to fundamental deterioration but rather to market participants’ preference for mega-cap growth. In fact, that scenario has prompted historically low multiples on small-cap value stocks.
One potential takeaway from the sentiment above is that OUSM has already established a leadership role in the small-cap value arena. The ETF could thrive even more should small-cap value rebound in earnest. The fund’s quality embrace could help.
“They (active managers) have also tried focusing on quality—metrics showing the strength and durability of an underlying business, such as profit margins, debt levels, and stable earnings over time,” concludes Morningstar’s Alpert.
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