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Large-cap stocks have been crushing small caps in the last few years. That’s, well, unusual, to say the least. And it’s set us up for cheap 7.2% dividends (with upside).
Small Caps Take a Detour
Small caps, of course, aren’t known for big dividends. The benchmark ETF for them, the iShares Russell 2000 ETF (NYSE:IWM)—in orange above—only pays 1.1%. But stick with me for a moment and I’ll show you how we’re going to pull this off.
Mega-Caps Steal the Spotlight, Setting Up Small-Cap Bargains
Around the time of the pandemic, small caps started lagging the S&P 500 after years of tracking it. Since then, the gap has widened. But there are signs a shift is in the works.
“Investors Look to S&P’s Forgotten 493 Stocks as Megacap Tech Wobbles” reads a recent headline from the Financial Times.
While perhaps a bit premature, the article does signal a new pivot.
Simply put, Big Tech, which dominates large caps and includes Apple (NASDAQ:AAPL), Alphabet (NASDAQ:GOOGL), Meta Platforms (NASDAQ:META) and Microsoft (NASDAQ:MSFT), has been soaring for a couple of years, drawing attention away from the rest of the market.
If we look at the concentration of the S&P 500—that is, the percentage of the index comprised of the 10 largest firms—we see a stunning trend.
Source: Apollo Global Management
Going by this chart, the 10 biggest S&P 500 firms make up a quarter of the index’s earnings and 40% of its market cap. In other words, Big Tech has been getting pricier and pricier in relation to the rest of the market since 2022.
That’s obviously unsustainable in the long run, and it could prompt investors to look for alternatives to the Apples and Alphabets of the world. As they do, small caps are likely to garner more attention, closing the gap with large caps. That would mean years of outperformance for these companies.
This Small Cap ETF Is Okay …
If this happens, expect IWM to start beating S&P 500 index funds. That outperformance could then reinforce itself as more investors buy, rewarding those who got in early.
There’s just one problem with IWM: that 1.1% yield. Lucky for us, there is a small-cap focused closed-end fund (CEF) paying a lot more. It’s been quietly crushing IWM, too.
… But This 7.2%-Paying CEF Beats It in Every Way
That would be the Royce Small-Cap Trust (NYSE:RVT), which focuses on smaller companies with promising cash flow growth.
RVT Outruns Small Caps
In purple above, we see RVT’s total net asset value (NAV) return, which shows the performance of its underlying portfolio so far this year, including dividends. While many investors haven’t heard of RVT holdings such as IES Holdings (NASDAQ:IESC) (IESC), Assured Guaranty (NYSE:AGO) or SEI Investments (NASDAQ:SEIC), these stocks have helped the fund not just profit but outperform.
With a near-10% NAV return, RVT is far ahead of the small-cap index’s 6.6%. That means RVT is generating “alpha”: earning more than the index it tracks. At the same time, the CEF’s total market price return is up 5.8%, so investors aren’t bidding up the shares as much as its fundamentals warrant. The result is this chart:
A Bigger and Bigger Discount
RVT’s discount to NAV, which measures the difference between NAV and the fund’s price on the open market, has been widening in 2025 and recently hit double digits for the first time in a year. That’s simply too big of a markdown.
This kind of thing happens with CEFs all the time. Often what follows is that investors rush in to fix the mispricing, resulting in capital gains on top of the fund’s income stream.
Speaking of income, while IWM yields 1.1%, RVT pays that 7.2% I mentioned earlier. That’s because, like most CEFs, RVT pays out as much of its profits as possible as dividends. This makes the fund and attractive way to invest in small caps, a notoriously volatile asset class. Getting part of our profits as dividends reduces our exposure to that volatility and gives us an income stream we can use however we like.
We could even pair RVT with a CEF holding different assets, using the income from one fund to buy the other when it’s oversold, and doing the reverse when it’s overbought.
This is the kind of strategy we use in our service, as it helps us secure a large income stream and position ourselves for gains without being overexposed to one part of the market.
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."