During last year’s market declines, large-cap emerging market indexes closely matched the small-cap emerging market indexes. This year, emerging market small-cap ETFs are performing in excess of large-caps, writes Kyle Waller for IndexUniverse. What it means:

• Positive Signal? The bulls say this is a sign of a strong bottom-up progress in developing countries, coupled with the ability of smaller companies to adapt as conditions change.

• Why An ETF? Using an ETF as your means for getting into small-caps in emerging markets can be beneficial, as many small companies in these markets can be difficult to research. Instead, the provider can do the legwork for you.

• More Risk? Small-cap emerging market companies are riskier than traditional emerging market investments, which usually translates into higher price volatility and liquidity issues. It’s also important to be mindful of any political instability and currency exchange rates. Have a strategy to help protect yourself.

• On the Plus Side…The rewards for investing would be the potential for above-average returns. These ETFs also can help lower a portfolio’s correlation to stocks focused on developed countries.

SPDR S&P Emerging Markets Small Cap (EWX) is more concentrated in Taiwan and China. WisdomTree Emerging Mkts Small Cap Div (DGS) is concentrated in Taiwan but it also has large holdings in South Africa, Korea and Israel. Vanguard Emerging Markets Stock ETF (VWO) has more exposure in China and Brazil.

• SPDR S&P Emerging Markets Small Cap (EWX): up 66.5% year-to-date; consumer goods is 18.7%, materials 18.2%, energy 2.7%, utilities 3.6%, health care 2.8%, consumer services 8.0%, business services 6.1%, financial 21.1%, software 1.8%, hardware 10.6%, media 2.3%, telecom 4.1%

• WisdomTree Emerging Mkts Small Cap Div (DGS): up 55.9% year-to-date; consumer goods is 17.6%, materials 18.1%, energy 3.0%, utilities 5.9%, health care 0.9%, consumer services 8.6%, business services 10.2%, financial 16.8%, software 1.2% hardware 13.0% media 1.2%, telecom 3.5%

• Vanguard Emerging Markets Stock ETF (VWO): up 51.6% year-to-date; consumer goods is 9.1%, materials 17.9%, energy 13.3%, utilities 5.1%, health care 2.9%, consumer services 3.1%, business services 1.7%, financial 22.4%, software 1.2%, hardware 9.0%, media 1.0%, telecom 13.3%

• iShares MSCI Emerging Markets Index (EEM): up 46% year-to-date; software is 1.7%, materials 19.1%, energy 12.4%, utilities 6.0%, hardware 12.4%, media 1.1%, telecom 12.1%, health care 2.0%, consumer services 2.6%, business services 1.9%, financial 22.2%, consumer goods 3.5%

For more information on emerging markets, visit our emerging markets category.

For full disclosure, Tom Lydon’s clients own shares of VWO.

Max Chen contributed to this article.

A case in point is the WisdomTree Emerging Markets High-Yielding Equity (DEM), which has so far managed to resist the downturn in energy and commodities by a big margin in the emerging market ETF space. Jeremy Schwartz, deputy director of research at WisdomTree, noted that because the fund did its annual rebalancing in June, the fund has been able to significantly outperform other similar funds in the emerging markets category.

When the rebalancing took place, the weights in energy and materials were reduced, because of the fund’s strategy of selling off stocks that had risen above their fundamentals or become “expensive,” while buying more of the cheap stocks.

In July, the commodities started their downturn.

“It was a little bit of fortuitous timing that oil went down,” he admits. But he points out that the recent events are a prime example of how the fund’s quant rules-based system really works. “You don’t have to decide. It’s a mechanical rules-based formula, based on total dividends paid.”

The fund takes those stocks with the top dividend yields, then winnows that list down to what is currently 310 holdings.

WisdomTree uses dividends to weight stocks because, among other things, cash dividends can be a measure of a company’s value and profitability.

So far, the strategy appears to work: the fund is down 2.6% year-to-date. It was outperforming other emerging markets ETFs before the rebalancing, but the latest moves only enhanced its performance:

• PowerShares FTSE-RAFI Emerging Markets ETF (PXH), down 14.2% year-to-date
• WisdomTree Emerging Markets Small Cap Dividend (DGS), down 15.7% year-to-date
• Vanguard Emerging Market (VWO), down 18.4% year-to-date
• iShares MSCI Emerging Markets (EEM), down 17.8% year-to-date

PowerShares also uses four factors to weight its stocks: dividends, cash-flow, book value and sales, and it to is outperforming the more traditional weighting methods used by VWO and EEM.

Between the fundamentally weighted ETFs, there’s no huge cost advantage, says Confused Capitalist for iStock Analyst. DEM and DGS are cheaper at 0.63%, while PXH is 0.85%.