Investors looking for exposure to smaller stocks while dodging laggard U.S. small caps do not need to take on significantly higher risk. An array of developed market small-cap exchange-traded funds (ETFs) are delivering impressive returns this year, including the WisdomTree International SmallCap Dividend Fund (DLS).
An easy way of looking at the WisdomTree International SmallCap Dividend Fund is that this ETF offers investors a dividend-paying alternative to the MSCI EAFE Small-Cap Index. That has been one of the best performing ex-U.S. developed market benchmarks this year, but DLS is not being left behind. DLS is up 17.3 percent year to date, an advantage of 200 basis points over the large-cap MSCI EAFE Index and better than triple the returns offered by the Russell 2000 Index. (See also: Global Economy on the Mend: 4 Small-Cap ETF Plays.)
Conventional wisdom dictates that international small caps, even developed markets fare, are often more volatile than their the U.S. counterparts. However, the Sharpe ratio for the WisdomTree International SmallCap Dividend Index, the index DLS tracks, indicates otherwise. "Looking at the rolling five- and seven-year Sharpe ratio comparisons, both the WisdomTree International SmallCap Dividend Index and MSCI EAFE Small Cap Index beat the MSCI EAFE Index in 100 percent of the rolling periods studied," said WisdomTree in a recent note. "The WisdomTree Index also had a higher Sharpe ratio than the MSCI EAFE Index in 100 percent of the rolling three-year periods studied."
As a dividend ETF, DLS can also be viewed as a smart beta fund, a status cemented by its dividend-weighted methodology. The geographic allocations in DLS underscore the ETF's dividend growth potential. DLS allocates 27.7 percent of its weight to Japan, home to some this year's best performing small caps, and it has significant dividend growth potential by virtue of including some of the most cash-rich companies. The U.K. and Australia, a combined 26 percent of DLS's weight, are also two of the best developed market dividend destinations. (See also: How Dividend-Paying ETFs Work.)
Overall, 23 countries are represented in the ETF. The DLS dividend advantage is also a volatility advantage as the ETF has had lower annualized volatility over the past three years than the MSCI EAFE Index and the MSCI EAFE Small-Cap Index. "Measuring the rolling period Sharpe ratios, on a three-year basis the WisdomTree International SmallCap Dividend Index beat the MSCI EAFE Small Cap Index two-thirds of the time," said WisdomTree. "Rolling five- and seven-year periods indicated the WisdomTree International SmallCap Dividend Index's risk-adjusted returns were better more than 90 percent of the time." (See also: Emerging Markets Dividends Are Working.)