With the Federal Reserve expected to continue raising interest rates later this year to combat stubborn inflation, investors are increasingly reassessing their exposure to rate-sensitive sectors such as technology and real estate. Both sectors are considered richly valued and vulnerable to rising rates, prompting a search for alternatives that offer growth potential without the same level of interest rate risk. Small-capitalization stocks are drawing attention as a possible answer.
Small-cap stocks often outperform when investors hunt for bargains and can deliver growth because these companies are typically at the beginning of their business cycle. They also tend to receive less attention from Wall Street, creating opportunities for active managers. The Russell 2000 Index, which tracks 2,000 small-cap U.S. companies, is up 13% year-to-date as of Oct. 5, with industrials, financials, and energy driving most of the gains. The S&P SmallCap 600 has risen nearly 15% over the same period, led by the same sectors. Past performance does not guarantee future results, and investment return and principal value will fluctuate, so shares may be worth more or less than their original cost when redeemed.
Beyond growth, small-cap stocks can also generate income, with some dividend-paying small-caps offering yields that outshine large-cap counterparts. This combination of regular dividend income and growth potential can provide a buffer against market swings and cash flow for reinvestment. However, identifying companies with reliable cash flow and growth requires careful analysis, which is where the Infrastructure Capital Small Cap Income ETF (NYSE: SCAP) comes in.
SCAP is an actively managed fund that seeks above-average yield by investing at least 80% of its net assets in an income-oriented portfolio of small-cap stocks. It is managed by Infrastructure Capital Founder, CEO, and Portfolio Manager Jay D. Hatfield, who brings nearly thirty years of experience in financial markets. His background as an investment banker, portfolio manager, and research director provides investors with access to a seasoned manager applying a proven approach to small-cap, income-paying stocks.
The fund targets above-average yield through small-cap stocks and the use of convertible and preferred securities, offering exposure to sectors such as aerospace and defense, homebuilding, casinos and gaming, regional banks, and mortgage REITs. With an expense ratio of 2.20%, the manager uses internal price targets based on the link between earnings growth and price-to-earnings ratios, along with selective option writing and modest leverage to generate additional income while retaining upside potential. As of the end of June, the 30-day SEC yield was 4.08%, reflecting annualized net yield from underlying dividends and interest. SCAP also seeks enhanced yield by writing index and single-stock options that reflect its own price targets.
Because the fund is actively managed, Hatfield and his team maintain relationships with issuer management teams to determine earnings estimates and forward-looking outlooks. This deep research allows SCAP to invest in companies earlier in their growth cycle, potentially capturing upside relative to market expectations given less analyst coverage. As interest rates possibly rise and volatility persists, small-cap stocks—particularly quality ones paying income—may offer a compelling alternative for growth-seeking investors. For more details, the fund's strategy was originally published on Benzinga, and additional disclosures are available here.
