How Quality Small-Cap Investing Navigates Volatility | ETF Trends

Recession, rising rates, the debt ceiling, and inflation have roiled markets this year. That volatility has made life difficult for lots of investors looking outside of durable mega-cap tech. It could be the right time for nimble, healthy small-cap firms to stand out. Indeed, small caps have seen a notable spike in interest according to VettaFi’s advisor data pool. That should invite investors to consider how quality small-cap investing can navigate volatility in the second half of the year.

Why quality small-cap investing? A quality screen has already helped investors avoid some of the year’s volatility, specifically the banking crisis. The ALPS O’Shares U.S. Small-Cap Quality Dividend ETF (OUSM) screened out risky financials names before the regional bank crisis hit. OUSM reweights its index for factors including quality, determined by financial statement metrics including return on assets and EBITDA.

See more: “Three Current Income ETFs to Watch as Inflation Holds

That’s allowed OUSM to maintain a financials allocation as its largest weight without needing those riskier names, according to VettaFi. OUSM’s next-highest weights include producer manufacturing and technology services.

Quality small-cap investing in this case also means dividends, normally the purview of larger firms. OUSM also weights its S-Network U.S. Equity Mid/Small-Cap 2500 Index for high dividend yields as well as low volatility stocks. The ETF currently offers a 2% annual dividend yield and just 15.76% volatility over the last 200 days according to VettaFi data.

That low volatility attribute could be important approaching a possible government debt default in the U.S. While investors don’t necessarily expect needing to watch party politics, debt default poses a very real risk to the markets.

Taken together, OUSM represents an intriguing strategy compared to its small and mid-cap competitors like the Vanguard Small Cap Value ETF (VBR).

A graph comparing VBR and OUSM YTD.

OUSM stands as a notable small-cap quality ETF based on YTD performance.

Adding $28.2 million over the last three months, OUSM has ridden its quality small cap investing approach to $228 million. For those investors looking for a strategy with a solid approach to nimble small caps, OUSM should make the shortlist.

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