Tap Quality to Play Small-Cap Surge | ETF Trends

Small-cap stocks outperformed large-caps last year and, as measured by the Russell 2000 Index (RUT), that scenario is carrying over into 2023.

The ALPS O’Shares U.S. Small-Cap Quality Dividend ETF (OUSM) is among the exchange traded funds dedicated to smaller stocks that are delivering the goods for investors in the early stages of 2023. OUSM is higher by 6.79%, as of January 25, outpacing the large-cap S&P 500 by 210 basis points in the process.

For OUSM, which follows the O’Shares U.S. Small-Cap Quality Dividend Index (OUSMX), that could be the start of something more substantial because small-caps are among the asset classes that market observers are most enthusiastic about for 2023. One reason for that bullishness is the track record of smaller stocks delivering upside when inflation is high but declining — the scenario investors see today.

In a recent CNBC interview, James Ashley, head of international market strategy at Goldman Sachs Asset Management (GSAM), detailed why the current environment could be favorable for small-caps.

“For example, there have been 20 years since 1950 when inflation began the year above 3% and ended the year lower; in these years, small-caps had a median return of 21%. In comparison, large-cap stocks returned 5%, according to GSAM’s research,” reported Ganesh Rao for CNBC.

While small-caps are viewed as volatile and economically sensitive, GSAM’s Ashley noted that the group has a tendency to outperform following two consecutive quarters of GDP declines — something the U.S. economy dealt with last year.

As ominous as a recession is, OUSM could be equipped to deal with that scenario. The ETF’s underlying index focuses on smaller companies with lower volatility, higher quality, and dividend growth traits — all of which can serve investors in times of economic duress.

Lower volatility is a relevant consideration with smaller stocks because, over the past three years, the annualized volatility on both the Russell 2000 and the S&P SmallCap 600 Index was north of 31%, according to ETFReplay data. Additionally, quality is an all-weather factor that many traditional small-cap ETFs don’t focus on, but it’s one that could benefit OUSM investors.

“[We] believe focusing on high quality small caps with resilient earnings is paramount this year. Many stocks on our list are well-positioned to weather an economic downturn, in our view,” wrote Bank of America strategist Jill Carey Hall in a recent report.

As of the end of 2022, OUSM beat the Russell 2022 over the trailing five years by 304 basis points, according to issuer data.

For more news, information, and analysis, visit the ETF Building Blocks 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.