iShares S&P Small Cap 600 UCITS ETF – An Unlikely 12.9% p.a. Dividend Grower – Investment Moats

I noticed during the process that iShares did a pretty good job collating the income distributions for their distributing class off shares.

This makes my job easier for us to look at dividend growth.

I am not a dividend investor, but in a way, dividend is a part of total return and it will be interesting to see the evolving stories of dividends.

Initially, I lament that iShares S&P SmallCap 600 UCITS ETF (ticker: ISP6) is not an accumulating class of shares but pays out an income distribution.

But I remember a rather interesting statistic I heard from somewhere that AVUV or the Avantis Small Cap Value ETF has some pretty sweet dividend growth.

So I thought why not do the same for ISP6.

The best thing is ISP6 was incepted in May 2008.

So it has at leas 16.5 years of performance and dividend data.

ISP6 tracks the S&P 600 index, which is the small cap that are profitable in the past few years.

Technically, this is not a group of stocks with dividends, but as you can see, they do pay out… 1.1% dividends on an average. A PE of 18 times doesn’t make small caps rather cheap, but they are still cheaper than their bigger brokers S&P 500 and S&P 400.

With ISP6 you can gain exposure to the profitable small caps.

Not that they bring much cheer this year. It did 8% in 2024 and then 9.66% year-to-date. The Russell 2000, with the unprofitable small caps, did 17.5% year-to-date. It does not mean that if you don’t have unprofitable companies, you will do better always! Especially in a year where the unprofitable companies like Biotech, miners, quantum computing, AI companies can really pulled returns up. So do you want profitable-only companies or the unprofitable ones? Tough choice. The empirical evidence tells us it is better to stick with the profitable ones.

Return Performance of ISP6 or the UCITS S&P 600 Small Caps

In the past 10 years, ISP6 gain 130% cumulatively. This includes dividends. Works out to an annualized return of 8.7% p.a.

Since it is incepted in 2008, we basically capture the full bull market of 16.5 years. The cumulative return is 356% or an annualized 9% p.a.

Last 5 years it did 50% or 8.4% p.a.

The S&P 500 would have done better, but I can also say if you pull this back to 1999 the ISP6 won’t look that bad versus the S&P 500.

What I find interesting would be the way they gain these 8-9% p.a. return.

This is the current top 50 holdings and weightage of the S&P 600:

You should play a game with your spouse or coworkers how many of these firms you guys know. And how come the top holding is not even 1% of the portfolio?

To some it is important to know but also greatly identify with what they invest in.

This is a top rule of theirs.

I can tell you… in this weird strategy, I don’t know a lot a lot of these companies. The board at S&P would regularly add, or remove stocks from this list.

Some of these companies will graduate to mid-caps or large-caps. Some will eventually die or become micro-caps.

But this very weird diversified S&P 600 did 10% p.a. by being so utterly unrecognizable.

That is 2050% since Jan 1994.

Makes you sometimes wonder what drives returns.

Here is the weekly price chart of ISP6 since inception (without the dividends):

Looks good. About 300% up. Uptrending but with some nerve-wrecking price action.

Very different from SEDY, which ended 14 years later down 20%.

And here it is if we factor in the distribution:

Looks no different!. This is about 357% up. That means dividend made up about 57% more.

Here is if you want to see it against the Russell 2000 ETF IWM:

Not too far off.

I think deliberating which is better and not investing eventually hurts more than anything.

ISP6’s Income Experience – Pathetic Starting Yield of 0.66%

ISP6 paid out US$0.12 in 2009/10 and given its price of US$18.21 in Jun 2009, the dividend yield is really.. 0.66%.

Using the same example as SEDY, if you had $2 million then, your dividend is $13,289 that year or $1107 monthly.

You will cry that this is not enough for you to spend!

Compared to SEDY’s $106,000 initial income on 5.3%, you can understand how unappealing

Indeed, this is like spending on a 0.5% safe withdrawal rate. Your income is very low, but is your income safe?

We shall see.

But it is so challenging to imagine if you painstakingly build up $2 million you can only spend $13,289 a year. This is why such ETF is so unattractive to retirees looking for income.

But you could sell some ISP6’s units to have a more livable yet conservative income.

“But Kyith, wouldn’t selling units just kill the income prematurely?”

I said sell units not sell until your portfolio is impaired. If ISP6 grows, the unit prices should not stay at US$18.

The following chart shows ISP6’s annual aggregated distribution:

Ok they probably didn’t collect 2 paychecks in 2008, but we could see the annual distribution grow from $0.145 in 2009 to $1.15 in 2025.

If end of 2009 is $22 the yield then is 0.66%.

If you have $2 mil, you end up with 90,909 units.

Your get $13,289 annual income from ISP6 in 2009.

In 2025 (16 years later), you will get $104,672 in income.($8722 monthly). SEDY’s income growth is negative.

And on top of that, your $2 mil portfolio is now $9 million.

This is income growth.

This ends up being an annualized 12.9% dividend grower.

It is remarkable if you consider:

1. You don’t have to select the stocks.
2. You don’t know the stocks.
3. Some of them cut or stop dividends, some of them raised dividend tremendously.
4. The whole strategy is never concentrated.

We saw a 14 years of SEDY’s investment experience and 16.5 years of ISP6’s investment experience.

You got to ask yourself which is a better experience:

1. Selecting a higher yielding strategy, ending with lower payout on your capital, and your capital lower than before.
2. Selecting a far lower yielding ETF, end up with 10 times payout on your capital, and your capital up 300%

Which one gives a greater peace of mind.

I think the answer lies somewhat in between because objectively speaking a income distribution of 0.66% is not enough for your spending needs. Spending only that is too conservative as well.

But you could use a Safe Withdrawal Rate of 3% to start spending, which mean in the initial years much of the income will come from selling ISP6’s units.

Selling units is necessary because you can also see the reality.

ISP6 happens to be one of the better dividend income growers.

But even it has years where the income distribution becomes lower than the previous.

As an income planner you should:

1. Balance with selling units to make up for the short fall.
2. Start your income planning with some income buffers (have greater capital).

Earnings Growth Drives Dividend Growth

How did the income grow like that?

First thing’s first, some data.

Here is the income distribution growth based on initial cost:

An initial low yield on cost became a pretty decent yield on cost.

But if you buy it at the start of every year, here is the prevailing yield:

ISP seldom trades at an attractive yield and if they did, its 1.2%.

In a way that is always the case that it looks unappealing until the dividend starts growing.

I plot the year on year income distribution growth in the chart below:

If you think the dividend grows by 3%, 3%, 3%, 3%, 3%, 3% every year, think again.

Some of these distribution revise up 30%, some 90%.

But why can dividend grow at such a rate?

Firstly the dividend distribution is likely the aggregate dividend distribution of the underlying companies, so the payout is the aggregate payout out of their income.

In order to pay for dividend over 16 years, they need to have cash flow.

And cash flow has to come from business.

If they earnings per share, or cash flow per share, or dividend is low to start with, that means their earnings grow over time.

Tobias Carlisle of the Acquirer’s fund posted the following chart of the S&P 600 forward earnings from 2009 to today, against the mid cap S&P 400 and large cap S&P 500:

This coincides with the time line that we are discussing ISP6.

People were surprised that the small caps grew earnings faster than the mid caps and large caps.

Perhaps this is the fundamental drivers for small caps good performance in the past. We can see from 2022 till today, earnings per share of small and mid caps stalled, while large caps went up.

Until very recently.

A single small cap is risky and uncertain if they will do well. The idea behind the strategy is one where you don’t know which will do well but buy a basket of 600 of them.

And this is the earnings growth as an aggregate. Pretty interesting when each allocation is so, so, so small and can do this right?

ISP6 did much better than SEDY because this period the earnings per share growth was better, and the dividend was raised as an aggregate at a much faster pace. There might be some reflexive effect in that higher dividends, leads to the company payout out more to be in greater demand, leading to higher share price.

In a lot of ways free cash flow/earnings per share growth leads to dividend growth.

So it makes you ponder again do you want a high starting yield or you want a reasonable yield but that will grow over time.

I am not recommending you to invest in ISP6 for income or retirement but to use it as an example to show you that focusing on the highest yield-on-cost might lead you to make decisions you eventually might not like.

Btw, I took this earnings growth chart from my collated Small Cap resource:

I collated a bunch of stuff that I came across about small cap over the years including:

• 99 years of total returns, rolling returns.
• Small cap in secular bulls and bears.
• Earners vs non-earners.
• Earnings growth profile.
• Earnings revision trends.
• Correlation to debt and China
• Impact of GDP
• Performance with USD
• Debt profile
• Debt/EBITDA trends.
• Short interests
• Impact of rising and falling 10-year interest rates.
• Russell 2000 seasonality.
• Performance after index gain 10% in a month.

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Kyith is the Owner and Sole Writer behind Investment Moats. Readers tune in to Investment Moats to learn and build stronger, firmer wealth foundations, how to have a Passive investment strategy, know more about investing in REITs and the nuts and bolts of Active Investing.

Readers also follow Kyith to learn how to plan well for Financial Security and Financial Independence.

Kyith worked as an IT operations engineer from 2004 to 2019. Currently, he works as a Senior Solutions Specialist in Insurance Start-up Havend. All opinions on Investment Moats are his own and does not represent the views of Providend.

You can view Kyith’s current portfolio here, which uses his Free Google Stock Portfolio Tracker.

His investment broker of choice is Interactive Brokers, which allows him to invest in securities from different exchanges all over the world, at very low commission rates, without custodian fees, near spot currency rates.

You can read more about Kyith here.