Increasingly, exchange traded fund (ETF) providers and investors are seeing the benefits of looking beyond broad emerging market funds. A new class of ETFs gives exposure to various slices of this segment, one of which is small-cap companies.
Over the last couple of years, MSCI has changed its methodology and its index is now heavily weighted to large-caps. The downside of this is that large-caps in these countries can be more sensitive to the whims of the global economy, since so much of what they produce (energy, materials and so on) is exported. Hence the case for small-caps. [Emerging Market ETFs: Growing Power On Two Fronts.]
State Street Global Advisors in an interesting recent whitepaper on the space suggested a 20% allocation to small-caps within one’s emerging market allocations to provide broader diversification. What are the benefits?
- Emerging market small-cap companies provides exposure to industrials, technology and consumer discretionary sectors.
- Small-cap companies in these markets give greater exposure to the domestic economy, including a growing level of internal consumption that we’ve been seeing in these countries.
- Small-caps perform better in recovery periods, which is what we’re in now, since they’re more nimble and quick to react.
Small-cap stocks represent 11% of developed market international equities, and 16% of emerging market equities. As of April 2010, the MSCI Index holds less than 5% exposure to small-caps.
One way to play emerging market small-caps is through the SPDR S&P Emerging Markets Small Cap ETF (NYSEArca: EWX), which tries to reflect the performance of the S&P Emerging Markets Under $2 Billion Index. The fund has an expense ratio of 0.66% and has 394 holdings. The top countries in the fund include Taiwan, China, South Africa, India and Brazil.
For more information on emerging markets, visit our emerging markets category. That’s not the only ETF giving exposure to small-caps in developing countries. Check out these funds, too:
- Vanguard FTSE All-World ex-U.S. Small Cap ETF (NYSEArca: VSS): Holds 23.5% in emerging markets.
- WisdomTree Emerging Markets Small Cap Div (NYSEArca: DGS): Holds Taiwan, South Africa, Thailand, Israel, Korea, Turkey and more.
- Market Vectors Latin America Small-Cap (NYSEArca: LATM)
- Market Vectors Brazil Small-Cap (NYSEArca: BRF)
- IQ South Korea Small Cap (NYSEArca: SKOR)
- IQ Taiwan Small Cap (NYSEArca: TWON)
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.