Small Caps Are Trending in Emerging Markets Too

Domestic small-cap stocks and the related ETFs are garnering plenty of attention this year and rightfully so. In some international markets, small-caps are also delivering solid performances. In the case of emerging markets, small-caps are performing less poorly than their large-cap counterparts.

For example, the WisdomTree Emerging Markets SmallCap Dividend Fund (NYSEArca: DGS) is down about 2% this year while the large-cap MSCI Emerging Markets Index is lower by more than 3%. DGS adheres to a smart beta, dividend-weighted strategy that has helped the fund outperform large-cap benchmarks over long holding periods.

“The cap-weighted MSCI Emerging Markets Small Cap Index has a greater weight to unprofitable companies and that can be found with 9.23% allocated to negative earnings and another 9.18% in a category with no data—this no data is likely because the companies were unprofitable—showing about 20% of the index in unprofitable stocks (similar to why these companies are not paying dividends above),” said WisdomTree in a recent note. “These stocks dramatically underperformed the market with both the N/A and negative earnings underperforming the broader market by more than 800 bps per year for over a decade. WisdomTree had much less exposure to these segments.”

Why Emerging Market Small Caps Make Sense

The $1.69 billion DGS turns 11 years old later this year. The fund’s underlying index yields 4.11%, or more than triple the dividend yield on the domestic Russell 2000 Index. Nearly 30% of DGS’ holdings are classified as mid-cap stocks.

“Another reason why it may make sense to invest in emerging market small caps is the different country and sector mix one can get in these companies,” said WisdomTree. “The sector exposure tends to be more Industrials, Consumer, Tech and Financials and less commodity-heavy sector exposure. This has resulted in small caps having less risk than large caps over the last decade.”

Related: Value ETFs Lag Growth, Momentum Counterparts

DGS allocates about 48 percent of its combined weight to the technology, industrial and consumer discretionary sectors. The ETF features exposure to nearly 20 countries, but Taiwan and China combine for nearly 45%.

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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.