Steady Returns in Unsteady Times: The BMO S&P US Small Cap ETF as a Dividend Anchor

In an era of geopolitical tension, rising interest rates, and market volatility, investors seek instruments that deliver stability. The BMO S&P US Small Cap Index ETF (ZSML.U), with its consistent quarterly dividends, low expense ratio, and diversified exposure to U.S. small-cap equities, emerges as a compelling option for Canadian investors navigating uncertain waters. This ETF combines defensive attributes with growth potential, offering a strategic balance for portfolios in turbulent times.

The Case for Stable Dividends in Volatile Markets

The ZSML.U's forward dividend yield of 1.45% (as of June 2025) provides a reliable cash flow source in an environment where bond yields are constrained and equity dividends are under pressure. This yield, supported by four consecutive quarters of stable CAD 0.14 dividend payouts, reflects the resilience of U.S. small-cap companies. Unlike large-cap giants, small-cap firms often exhibit stronger earnings growth and agility in adapting to macroeconomic shifts, particularly in sectors like AI-driven tech and healthcare innovation, which currently dominate the S&P SmallCap 600 Index.

The ETF's dividend stability contrasts sharply with the volatility of its net asset value (NAV). While U.S. small-cap equities face risks such as sector-specific overvaluation or a slowdown in tech spending, the dividend history demonstrates a commitment to income generation. This consistency is further bolstered by the ETF's low expense ratio of 0.25%, which minimizes drag on returns and positions it competitively against peers.

Hedged vs. Unhedged: Navigating Currency Risk

For Canadian investors, the decision to choose between the hedged (ZSML-F.TO) and unhedged (ZSML.U) share classes hinges on currency exposure. The U.S. dollar's strength in early 2025—near multi-year highs against the Canadian dollar—has made hedging a critical consideration.

• ZSML-F.TO (Hedged): Ideal for investors prioritizing capital preservation. By neutralizing CAD/USD fluctuations, this share class reduces volatility while still benefiting from U.S. small-cap growth. The ETF's correlation of 0.65 with the S&P/TSX Composite underscores its diversification value.
• ZSML.U (Unhedged): Suitable for investors who believe the Canadian dollar will weaken further or who seek direct USD exposure. This option retains currency risk but offers a pure play on U.S. small-cap performance.

The Defensive Edge of U.S. Small-Caps

Small-cap equities historically outperform large caps during economic expansions and recovery phases. The S&P SmallCap 600 Index, which ZSML.U tracks, currently tilts toward growth-oriented sectors such as semiconductors, biotechnology, and cloud infrastructure—areas poised to benefit from innovation-driven spending.

Moreover, small caps trade at a 20% discount to large-cap valuations, offering a margin of safety. While risks exist—including sector concentration and sensitivity to interest rate hikes—the ETF's broad diversification (over 600 holdings) mitigates idiosyncratic risk.

A Portfolio Staple in Uncertain Times

In a market where correlation between asset classes is rising, ZSML.U's low correlation with Canadian equities makes it a valuable diversifier. For Canadian investors, a 5–10% allocation to ZSML-F.TO could anchor a portfolio during periods of equity market stress, while allocations to ZSML.U might appeal to those with a longer-term USD outlook.

Investors should note, however, that U.S. small-cap exposure carries risks: a prolonged economic slowdown or a tech-sector correction could pressure returns. Pairing ZSML.U with defensive sectors (e.g., utilities, consumer staples) or inflation-linked bonds would further balance risk.

Final Considerations

The BMO S&P US Small Cap Index ETF (ZSML.U) is not a speculative play but a foundation-building tool. Its dividend reliability, sector exposure, and hedging flexibility position it as a defensive yet growth-oriented holding. In a world where uncertainty is the only certainty, this ETF offers a rare blend of stability and opportunity.

For Canadian investors, the choice between hedged and unhedged versions depends on their currency outlook, but both share classes merit consideration. As markets oscillate between optimism and caution, ZSML.U's steady hand remains a worthwhile ally.

Final Note: Always assess individual risk tolerance and consult with a financial advisor before making investment decisions.