Small Cap Value Has Been Getting Crushed—Until Now

dividends
gannatti
05/02/2016
Small-cap value is an investment strategy that, over long periods, has delivered prolific results. But that doesn’t mean that it always outperforms. Every investment strategy can and does succumb to periods of underperformance. Since WisdomTree has launched its dividend-focused Indexes in June of 2006, small-cap value—defined as the Russell 2000 Value Index—has distinctly underperformed small-cap growth, defined as the Russell 2000 Growth Index.   We’re Talking about a Cumulative Difference of More than 30% Cumulative Difference Small-Cap Dividend Payers The WisdomTree SmallCap Dividend Index is a value strategy because very few small-cap growth companies in the United States pay regular dividends. It is therefore remarkable that the WisdomTree SmallCap Dividend Index underperformed the Russell 2000 Growth Index by only half of one percentage point on a cumulative basis over this period of nearly 10 years. Why? 1) Interest Rates: If we’re thinking of the period from June 1, 2006, to March 31, 2016, the bulk of that period was characterized by extremely low interest rates that only started on the path to normalization in December of 2015. The income-generating potential of the Real Estate and Utilities exposures over the course of the WisdomTree SmallCap Dividend Index’s history could explain the desirability of the income from these types of stocks. 2) Rebalancing: Every year, the constituents of the WisdomTree SmallCap Dividend Index that raise their dividends more than other U.S. small-cap stocks get greater weight in the Index. The process tends to tilt away from stocks whose prices have appreciated faster than their dividends, and it does this at a regular, annual frequency.   Is 2016 an Inflection Point? Predicting inflection points where one style of investing goes from outperforming to underperforming is very difficult to do accurately and consistently over time. It is possible, based on the admittedly early performance data for 2016, that such a switch could be under way. Through March 31, 2016, the Russell 2000 Value Index has delivered outperformance on a cumulative basis against the Russell 2000 Growth Index. There is no way to know if this will continue, but we find it interesting that the WisdomTree SmallCap Dividend Index held up very well in what many would consider a non-favorable environment, characterized by the outperformance of growth over value. If value begins to outperform, it stands to reason that the overall environment could be more favorable to a dividend-focused, small-cap U.S. strategy.   Don’t Forget about Small-Cap Dividend Payers The WisdomTree SmallCap Dividend Index has a dividend yield of 3.9%. Only about 20% of its weight had a dividend yield below that of the U.S. 10-Year Treasury note as of March 31, 2016.1 If small-cap value is a style that comes into favor in 2016, and if interest rates remain low for an extended period, this could be a very interesting strategy to consider.     Unless otherwise noted, data source is Bloomberg, with data from 6/1/2006 to 3/31/2016.         1Source: Bloomberg.

Important Risks Related to this Article

Dividends are not guaranteed, and a company’s future ability to pay dividends may be limited. A company currently paying dividends may cease paying dividends at any time.  

Investments focusing on certain sectors and/or smaller companies increase their vulnerability to any single economic or regulatory development.

 

About the Contributor
gannatti
Head of Research, Europe

Christopher Gannatti began at WisdomTree as a Research Analyst in December 2010, working directly with Jeremy Schwartz, CFA®, Director of Research. In January of 2014, he was promoted to Associate Director of Research where he was responsible to lead different groups of analysts and strategists within the broader Research team at WisdomTree. In February of 2018, Christopher was promoted to Head of Research, Europe, where he will be based out of WisdomTree’s London office and will be responsible for the full WisdomTree research effort within the European market, as well as supporting the UCITs platform globally. Christopher came to WisdomTree from Lord Abbett, where he worked for four and a half years as a Regional Consultant. He received his MBA in Quantitative Finance, Accounting, and Economics from NYU’s Stern School of Business in 2010, and he received his bachelor’s degree from Colgate University in Economics in 2006. Christopher is a holder of the Chartered Financial Analyst designation.