Big Performance from Small-Cap ETFs

11/05/2013 9:00 am EST

Focus: STRATEGIES

In the six major inflationary periods since World War II, small-caps beat large-caps. When you add up the returns over all six periods, small-caps were up 82.6%, versus just 35.1% for large-caps, observes Philip Springer, in Survival of the Fittest.

We've found two high performing small-cap indexes that take vastly different approaches, but are consistent in their approach in identifying high earnings power companies.

WisdomTree SmallCap Earnings Fund (EES) follows earnings generated by companies in the small-cap universe of the US stock market.

Furthermore, the fund looks to weight by earnings, giving bigger weights to firms that earn more, irrespective of market capitalization.

Sector wise, this exchange-traded fund is heavy in financials and consumer discretionary stocks; these two sectors each account for more than 20% of the portfolio, followed closely by industrials and technology.

Assets are well spread out across the components, as only one company accounts for more than 1% of the portfolio.

The fund's performance has been exceptional. The ETF also has a solid track record over long time periods, posting gains in excess of 35.6% over the trailing one year. WisdomTree SmallCap Earnings Fund is a buy up to $85.

WisdomTree SmallCap Dividend ETF (DES) invests in dividend-paying small-cap companies that meet certain liquidity requirements. It then weights them by the dollar value of dividends they are expected to pay out over the next year.

While the fund's holdings skew toward the small-value side, on average they trade at richer valuations than the holdings of its peers.

Yet, according to some analysts, since its inception in July 2006, this ETF has behaved more like a deeper value fund than nearly all of its counterparts.

We reiterate that value investments trump growth investments during inflationary periods. The fund's dividend-weighting approach may offer a partial explanation.

According to one analyst, "When it rebalances, the fund increases its exposure to stocks that have become cheaper, relative to their dividends and pares back on those that have become more expensive, regardless of where these holdings fall in the style box. This dynamic approach may allow the fund to capture the value premium more effectively than many of its peers." WisdomTree SmallCap Dividend ETF is a buy up to $70.

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