Exchange traded fund investors may be missing out on an opportunity in the small- and mid-cap international equity market segment.
“While US investors recognize the potential growth and diversification benefits US SMIDs offer – with 13.3% of their portfolios in them – they seem to have overlooked international SMIDs. According to Morningstar, they have just 0.8% of their portfolios in this asset class. Given the high quality and low valuations this asset class has offered, it seems to be an opportunity worth closer consideration,” Alice Fricke, Senior Client Portfolio Manager, Invesco, said in a research note.
Fricke pointed out that on measures such as return on equity measures, international SMID companies are higher quality. They have been trading on average at a 40% discount to US small- and mid-caps. Yet, investors have not taken advantage of this opportunity.
For international companies that are considered “SMID-cap”, Invesco has found that they are generally export-oriented, globally structured, innovative, and have a high to dominant share of a niche market, often one in which the U.S. counterparts don’t compete effectively.
On the other hand, Invesco believes U.S. small- and mid-caps have it easier than their international peers. Smaller U.S. companies benefit from operating in one of the easiest countries for commerce. The US regularly places near the top in the World Bank’s annual rankings of countries for its ease of doing business. The companies have access to a population of 330 million consumers who speak one language, and they operate one set of national laws and regulations.
As a way to help track this segment of the global market, investors can look to the Invesco FTSE RAFI Developed Markets ex-U.S. Small-Mid ETF (NYSEARCA: PDN). PDN is based on the FTSE RAFI Developed ex U.S. Mid-Small 1500 Index, which is comprised of small and mid-capitalization equities of companies in developed international markets (excluding the US), selected based on four fundamental measures of firm size, including book value, cash flow, sales and dividends. The equities are based on their fundamental strength and are weighted according to their fundamental scores.
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