The Russell 2000, a small-cap index, has recently been facing some profitability challenges. After registering a solid gain of 10.1% in July, the index has plummeted by approximately 4% in August. According to ALPS’ Paul Baiocchi, this erratic behavior can be attributed to the overall composition of the index. Shockingly, a report from Apollo Global revealed that a staggering 40% of companies included in the Russell 2000 are currently operating at a loss.
Investors in the Russell 2000 seem to have reluctantly accepted this reality. The prevailing sentiment among investors is that being part of the index means riding the waves of both positive and negative returns. Baiocchi, ALPS’ chief ETF strategist, advised investors to sift through the rubble and focus on quality companies. He suggested looking into more selective exchange-traded funds, such as ALPS O’Shares U.S. Small-Cap Quality Dividend ETF Shares (OUSM).
The key idea behind Baiocchi’s recommendation is to target quality companies that not only pay dividends but also have a track record of dividend growth. He emphasized the importance of selecting companies with lower volatility compared to their peers. This approach enables advisors and investors who have been stuck in a rut with small caps for five years to reallocate their assets to an underperforming category.
Apart from its profitability criteria, OUSM is distinguished by its concentrated portfolio. With just 107 stocks, OUSM pales in comparison to the sheer number of holdings in the Russell 2000. The fund’s top three positions are Tradeweb Markets, Juniper Networks, and Old Republic International, each accounting for approximately 2% of the fund’s total weight, according to FactSet data. OUSM has experienced a modest decline of 1.5% month-to-date, surpassing the Russell 2000 by more than 2 percentage points during the same period.
The profitability woes of the Russell 2000 have shed light on the importance of quality in small-cap investing. By prioritizing quality companies with strong dividend growth and lower volatility, investors can navigate the challenging landscape of small-cap stocks. OUSM exemplifies this approach, offering a concentrated portfolio of quality companies that have the potential to outperform their counterparts in the long run.