WisdomTree US SmallCap Dividend ETF: There Are Better Alternatives

ETF Overview

WisdomTree U.S. SmallCap Dividend ETF (NYSEARCA:DES) owns a portfolio of small cap dividend stocks in the United States. The fund has high exposure to cyclical sectors. Since 2023 is going to be a year of economic uncertainty and that small-cap stocks will be less immune to a recession than mid or large-cap stocks, DES may not be the best place to put your cash to work. Hence, it is better to consider an investment in mid or large-cap dividend stocks instead.

Fund Analysis

Positives of DES

Although our title of this article already suggests that we think there are better alternatives out there, to be fair, we think it is still necessary to mention some of the positives of this fund first before we analyze the negatives of DES.

First, the fund has delivered an annualized return of about 8.6% in the past 10 years. DES’s total return of 22.7% in the past 3 years was also slightly better than the 20% return of the Russell 2000 index, which consists of solely small-cap stocks. Second, DES has a beta of 1.1 (measured in the past 5 years) relative to the S&P 500’s beta of 1. Although this means that DES is more volatile (which is expected for a fund consists of small-cap stocks), it also means that DES has the potential to outperform the broader market in a bull market.

Negatives of DES

Now that we have identified some positives of DES, we will look at some of the negatives of this fund.

High exposure to cyclical and rate-sensitive sectors

First, DES has a high exposure to cyclical and rate-sensitive sectors. As can be seen from the table below, most of the subsectors except consumer staples, health care, utilities and communication services belong to cyclical or rate-sensitive sectors. Together, these sectors represent over 84% of the total portfolio

Normally, this high exposure to cyclical and rate-sensitive sectors is not a big problem especially in an economic boom. However, the rise of inflation and the Federal Reserve’s effort to tame inflation will cause some challenges to the economy. It also has the potential to tip the economy towards a recession. Therefore, there is plenty of uncertainty ahead in 2023. As the strength of the economy weakens, cyclical and rate sensitive stocks will likely be impacted negatively. Therefore, it may not be the right time to own DES now.

Small-Cap dividend stocks do not outperform mid and large-cap dividend stocks in the long term

Second, small-cap dividend stocks do not outperform mid and large-cap dividend stocks in the long run. While every large-cap stock was once a small-cap stock, not all small-cap stocks will become large-cap stocks. Hence, DES’s portfolio of small-cap dividend stocks does not mean all of them have strong growth potentials. In fact, DES’s portfolio do not have a high exposure to strong growth sectors. As we know, one sector that has strong long-term growth potential is the technology sector. Unfortunately, information technology stock only represents about 4.97% of DES’s portfolio. This limited exposure to fast-growing sector means that the growth rate will be limited.

The following chart best illustrates the point we want to make. As can be seen from the chart below, DES achieved a total return of 127% in the past 10 years. This is not too bad. However, its peers WisdomTree US MidCap Dividend ETF (DON) and WisdomTree US LargeCap Dividend ETF (DLN) achieved much better total returns of 174% and 188% respectively. While DES’s distribution yield of 2.65% is better than DON’s 2.53% and DLN’s 2.48%, the difference is slim. Investors should pay attention to total returns instead.

Should you invest in DES in 2023?

We think 2023 is going to be a year of turmoil. Therefore, we should carefully consider the downside risk before making any investments. Since small-cap stocks tend to be less immune to an economic recession, it will likely underperform its mid-cap and large-cap peers. As can be seen from the chart below, DES has fallen the most almost in every major market correction. Hence, for dividend investors, the best strategy is not to own DES right now, but to own large-cap dividend ETFs such as DLN.

Investor Takeaway

Small cap dividend stocks is not one that investors should invest at the moment. As our analysis suggests, both mid-cap and large-cap dividend ETFs offer better downside protection and upside potential in the long term. Therefore, why bother investing in DES? We had rather put my money elsewhere.