U.S. small-caps have rebounded in style this year as highlighted by gains of better than 3% for the iShares Core S&P Small-Cap ETF (NYSEArca: IJR) and the iShares Russell 2000 ETF (NYSEArca: IWM).
However, investors should not ignore the potential of international small-caps, either. That asset class can be accessed with a number of exchange traded funds, including the cost-efficient Vanguard FTSE All World ex-US Small-Cap ETF (NYSEArca: VSS). VSS, which saw its expense ratio pared last year, charges just 0.19% year, or less than 88% of rival funds. [Vanguard Pares Fees on Some ETFs]
VSS has easily outpaced its U.S.-focused rivals in 2015 with a gain of 4.5%. However, small-cap shares are known for the higher level of volatility and risk. Small-cap companies are qualified as those that have a market cap between $300 million and $2 billion. The benefit of an ETF such as VSS is portfolio diversification, particularly for investors that already own large-cap international ETFs that are heavy on familiar, multi-national names.
“International small caps, on the other hand, tend to generate a greater share of revenue in their respective domestic markets. As a result, a portfolio of international small caps has historically offered more diversification benefits, relative to a portfolio of international large caps, for a U.S.-based investor,” according to a recent Morningstar research note.
VSS makes good on the promise of diversification. The $2.7 billion ETF holds just over 3,300 stocks an its top 10 holdings combine for just 3% of the fund’s weight. VSS’ portfolio is somewhat Europe heavy with 41.6% of its geographic weight going to European nations. Adding to developed markets heft is a 26.4% weight to developed Asia-Pacific markets.
VSS does mix in a nearly 19% weight to emerging markets small-caps, but the U.K., Japan and Canada combine for 44% of the ETF’s weight.
Small-cap companies tend to be U.S. focused and are more closely tided to the well being of the U.S. economy. With the U.S. economy on the rise and low energy prices fueling growth, smaller company stocks could continue to outperform. [Small-Cap ETFs for U.S. Growth]
That is also true of international small-caps as it pertains to their home markets, but VSS is not a currency hedged ETF, a trait that must be acknowledged at a time of dollar strength. Still, VSS offers plenty of advantages of compared to rival actively managed mutual funds, which often carry heftier fees.
“As an index fund, it has had low turnover and has not made a capital gains distribution over the past four years. This compares favorably to actively managed small-cap funds, which tend to have higher turnover and more capital gains distributions. In the 12 months ended February 2015, this fund’s tax-cost ratio (which measures the cost of taxes from both dividends and distributed capital gains) was 1.09 versus the category average of 1.85,” according to Morningstar.
Vanguard FTSE All World ex-US Small-Cap ETF
