U.S. small cap ETFs space saw a great start this year courtesy of steady U.S. economic growth, especially compared to the other parts of the developed world. The economy’s growth rate moderated to 2.2% in Q4 from an impressive 5% in Q3 and 4.6% in Q2 of 2014, yet investors pinned their hope on sustained recovery.

Normally, smaller companies pick up faster than the larger ones in a growing economy. Since these pint-sized securities usually focus more on the domestic market, they are less ruffled by international worries than their globally exposed larger counterparts. As a result, small-caps are leading the way this year, with iShares S&P Small-Cap 600 Growth ETF (IJT) having added more than 6% in the year-to-date frame (as of March 18).

In such a situation, the Fed came up with a caution stance on domestic growth. The central bank also slashed the U.S. economic growth projection (considering the central tendency method) for 2015 from 2.6−3% (guided in December) to 2.3−2.7%. The growth projections for 2016 and 2017 were also cut to 2.3−2.7% and 2.0−2.4%, respectively, from 2.5−3% and 2.3−2.5%.  

Plus, the Fed seeks further stabilization in the labor market and inflation numbers before taking a decision of hiking interest rates. While a strong possibility of delayed rate hike should spur the small-cap ETFs space, moderation in economic growth is no less a threat. In such a situation, a value or dividend play could soothe investors’ nerves to some extent.

Small-Cap Dividends on the Rise

Per Financial Times, dividend initiations or increments have prevailed among the small-cap U.S. companies over the last 15 months. More than 50% of the 600 companies in the small-cap index pay out a dividend now. The figure lags the S&P 500 by 15 bps but surpasses its mid-cap counterparts by 12 bps.

Over the last 20 years ending December 2014, dividend issues in the S&P Small Cap 600 index grew about 22.3% compared to a 3.4% decline in the S&P 500 index. As per S&P Dow Jones indices,  at the current level, ‘202 issues will pay more than they paid in 2014; 255 paid more in 2014 than 2013 and 139 paid more in 2013 than 2012’.

In such a backdrop, small-caps with a tilt toward value notion and dividend focus might seem intriguing ideas. Below, we have highlighted some of the small cap high yield ETFs that are outperforming in the small cap space and could be ones to watch in the months ahead (read:Investor Guide to Small-Cap Value ETFs).

SmallCap Dividend Fund (DES)

DES looks to track the performance of the WisdomTree SmallCap Dividend Index. The fund is one of the popular choices in the small-cap value space with about $1.21 billion in AUM. It is a low cost (38 bps) option in the small-cap value ETF space.

Holding more than 700 stocks in its basket, the product puts about 10% of its total assets in the top 10 holdings, suggesting low concentration risk. Sector wise, this ETF is heavy on financials (24.9%) followed by industrials (15.7%) and consumer discretionary (15.6%).

The fund has lost about 0.4% in the YTD time frame, though it was up about 2.3% in the last one week (as of March 18, 2015). DES has a yield of 2.45% per annum. The fund carries a Medium risk outlook along with a Zacks ETF Rank #3 (Hold).

PowerShares S&P SmallCap Utilities Portfolio (PSCU)

The utility sector in any case is known for high dividend payouts and stability. Only one glitch associated with the sector is the rising rate concern. However, with this very concern now apparently taking a pause due to a backward shift in the timing of interest rate hike, the utility sector should perform well this year (read: 3 Best Performing Small Cap Sector ETFs of 2014).

A good way to play this trend is with PSCU, which follows the S&P Small Cap 600 Utilities Index. This fund added 2.4% in the last five trading sessions (as of March 18, 2015). The ETF has accumulated $42.6 million in its asset base while volume is paltry at 5,000 shares a day, suggesting additional cost in the form of a wide bid/ask spread beyond the expense ratio of 0.29%.
 
Holding 20 stocks, the product is concentrated on the top 10. The dividend yield of the fund was 2.39% (as of March 18, 2015).  PSCU has a Zacks ETF Rank #2 (Buy) with a Medium risk outlook.

S&P SmallCap Low Volatility Portfolio (XSLV) 

The fund seeks to match the price and performance of the S&P SmallCap 600 Low Volatility Index. This product is appropriate for investors looking to participate in U.S. small cap market growth while limiting portfolio volatility (read: Can Small Cap Low Volatility ETFs Continue Their Hot Streak?).
 
The fund is well spread out across various components as each security holds less than 1.43% of total assets. However, the product is heavily dependent on the financial sector at 55.1%, with industrials and utilities also taking double-digit exposure. The fund puts about $77.3 million of assets in 120 holdings. The fund was up 3.9% in the last five trading sessions (as of March 18, 2015). The fund had a dividend yield of 2.38% (as of the same date). 
 
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