Investors seeking to diversify their international portfolios should also consider small-cap exchange traded fund options.
For instance, the Vanguard FTSE All World ex-US Small-Cap ETF (NYSEArca: VSS) tracks the FTSE Global Small-Cap ex-US Index, which provides exposure to 3,241 small-cap global companies taken from 43 countries.
“The main reason to own international small caps is diversification,” according to Patricia Oey for Morningstar.
Since many large-cap international companies would compete with U.S. multinationals, investors may gain a more focused exposure to global markets through international small-caps that generate a grater share of revenue in their respective 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,” Oey added.
Looking at international small-caps’ risk profile, smaller companies are not much more volatile than their larger counterparts. For instance, the standard deviation for the FTSE Global Small Cap ex-US Index was 17.6% over the trailing five years, whereas the FTSE All World ex US Index showed a standard deviation of 16.6%.
However, potential investors should be aware that VSS does not hedge currency risks. Consequently, if foreign currencies continue to depreciate against the U.S. dollar, the international ETF’s USD-denominated returns may be lower.
Additionally, VSS includes a larger-than-average 12% emerging market position, whereas other small- and mid-cap blend funds typically show a 2% allocation toward developing economies. VSS also holds a greater tilt toward Canada at 12%, Taiwan 7% and Japan 15% than the category average.
The FTSE Indexing methodology slightly differs from the MSCI methodology in that VSS tracks companies that fall in 91% and 98% by market cap, whereas the MSCI ACWI ex US Small-Cap Index tracks companies that fall between 86% and 99% by market cap. Moreover, FTSE overweights Canada and Taiwan while MSCI overweights Japan.
Vanguard FTSE All World ex-US Small-Cap ETF
For more information on global markets, visit our global ETFs category.
Max Chen contributed to this article.