ETF investors looking for small-capitalization U.S. market exposure should consider a dividend growth strategy that could potentially generate improved risk-adjusted returns over the long haul.
The ProShares Russell 2000 Dividend Growers ETF (BATS: 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.
“The Russell 2000 Dividend Growth Index includes companies with high dividend growth plus small cap exposure,” Tom Goodwin, senior research director of FTSE Russell, said in a note. “With dividends reinvested, its relative performance compares favorably to its benchmark…. Not only have the returns been higher than the parent Russell 2000 Index since going live, but volatility and drawdowns have been substantially less.”
Since its inception on November 11, 2014, the Russell 2000 Dividend Growth Index has generated an annual 13.4% return with an annual 13.5% volatility, whereas the benchmark Russell 2000 Index showed a lower return of 7.6% with a higher volatility of 16.5%.
By focusing on companies that have consistently increased dividends every year for the past decade, the Russell 2000 Dividend Growth Index avoids the so-called yield trap where a stock can have a high dividend yield following a steep decline in price.
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Running a regression model of the Russell 2000 Dividend Growth Index, FTSE Russell found that the dividend growth strategy exhibited relatively low sensitivity to broad market moves, which has lead to lower overall volatility and drawdowns for the index and SMDV. Historical data revealed that higher dividend paying and dividend growing stocks tend to have better valuations. Lastly, the portfolio’s exposure to quality or companies with strong profitability growth, high return on assets and low volatility, among other things, have contributed to the outperformance.
“The factor analysis shows that, by selecting companies that have successfully increased their dividend payments over many years, the Russell 2000 Dividend Growth Index occupies a corner of the small cap space that is high in the Quality factor,” Goodwin said. “The returns to the Small Cap and Value factors have varied significantly over the last couple of years, but the Market Beta and Quality factors have shone through, buoying up the performance of the index. Those two factors combined with the Small Cap factor makes for three strong drivers of index performance.”
SMDV has a large tilt toward the utilities sector at 25.2%, followed by financials 19.7%, industrials 15.5%, consumer staples 11.5% and materials 10.4%. The underlying index shows a dividend yield of 2.39% and dividends are paid on a quarterly basis. The ETF comes with a 0.40% expense ratio.