Small caps are (finally!) back, but most people are in the dark about how to tap them for serious dividends. But there is a proven way to do that—one that puts a rich 7.1% payout squarely on the table for us.
Everyone has missed this one. We’re going to dive into it today.
The main reason I hate to see people ignore small caps—especially now—is that, well, their time has come.
Small Caps Have Lagged for Years—And They’re Due for a Bounce
As you can see, It’s been a solid decade of small-caps delivering, well, small profits to investors. But it’s time for the script to flip. In fact, it’s already happening:
Small Caps See a Summer Bounce
After years of being dusted by big caps, small caps are matching them point for point this year—even pulling ahead, going by the performance of the benchmark iShares Russell 2000 ETF (NYSE:) in orange above, over the last three months.
I see that continuing.
For one, small firms tend to have close, personal relationships with clients, keeping their loyalty—and small firms’ sales along with it—strong. Moreover, they tend to be domestic, so they directly profit from the US economy’s strength (which we discussed in last Thursday’s article) and get a hedge from global headaches (including on trade), too.
But What About the Dividends?
Of course, there are drawbacks to buying these “small fry”: For one, unless the company is near where you live, say, or factors into your work life, you probably don’t know much about it. That’s unlike, say, big caps like Microsoft (NASDAQ:), which get loads of analyst and media coverage.
Another, of course, is the dividends. Many small caps are earlier in their growth process—and if they’re lucky, on their way to becoming tomorrow’s large caps. Unfortunately, this means many can’t afford to both fund that growth and pay dividends.
This is why, for the most part at my CEF Insider service, we’ve focused on closed-end funds (CEFs) that hold large caps and high-yield bonds. Not only have they delivered bigger gains than small caps, but they’ve been handing us high, steady dividends, too.
You get a sense of that when you compare the average CEF yield—8.3%—with the payout on the small-cap benchmark iShares Russell 2000 ETF (IWM): a mere 1%.
Still, every rule has its exception.
When it comes to small caps, that exception is a CEF called the Royce Small-Cap Trust (NYSE:). This fund (in orange below) has closely tracked small caps, but with a twist: It “translates” small cap gains into dividends—7.1% payouts, to be exact.
RVT Turns Small Cap Gains Into Dividend Cash
The power of a fund like RVT is in its structure: the managers at Royce Investment Partners invest in many different small caps—488, to be exact.
Its three top holdings are IES Holdings (NASDAQ:) (IESC), Assured Guaranty Ltd (NYSE:) (AGO) and SEI Investments (NASDAQ:). Note this chart:
Top Holding Explodes, 2 Others Gain
IESC (in blue above) installs electrical and technology systems for businesses and had $2.9 billion of sales in its latest fiscal year. Revenue soared 16% in the latest quarter on strong data-center growth (no surprise there). Meantime over at financial firm SEIC (in orange), EPS jumped 70% and revenue jumped 8% in the latest quarter, driven in part by higher interest in alternative investments.
As for financial-insurer AGO (in purple), the firm saw net income rise 32% in the last quarter as municipalities continued rolling out bonds at a record pace.
All of these stocks’ gains are pushing up RVT’s net asset value (NAV, or the value of its underlying portfolio), putting a lift under its share price. Royce’s job is to take profits on its winners and use its gains to buy up-and-comers and maintain its 7.1% dividend.
Now, to be sure, RVT’s dividend does float a little. That’s because it has a mandate to pay dividends at a yearly rate of 7% of the average of the last four quarters of NAV (calculated at quarter-end). So if NAV rises, payouts do, too.
I like this payout strategy because it means the fund is not bound to a fixed payout and has flexibility to reinvest gains in other opportunities where it sees them. And even with that flexibility, RVT’s dividend has been remarkably consistent (and even up modestly) over the last five years:
Source: Income Calendar
Moreover, RVT is still available at a 9.2% discount to NAV. That markdown has momentum, too, up from double digits in late August.
RVT Is Cheap, With a Discount Trend We Like
Given that RVT’s discount shrunk below 6% in January, before tariff fears sent it plunging in the spring, we still have potential for upside on a closing discount here.
The bottom line is that RVT has been doing a good job of “translating” small cap gains into 7% dividends for a long time. That’s why, as small cap momentum ramps up, we see the fund as a good one in which to slowly build a position.
Disclosure: Brett Owens and Michael Foster are contrarian income investors who look for undervalued stocks/funds across the U.S. markets. Click here to learn how to profit from their strategies in the latest report, “7 Great Dividend Growth Stocks for a Secure Retirement.”