A Smart Beta ETF Idea for Smaller Equity Exposure

U.S. small-caps and the related ETFs have recently been rebounding, but the truly impressive 2017 performances with smaller stocks are found outside the U.S.

Some smart beta ETFs tap into that theme, including the PowerShares FTSE RAFI Developed Markets ex-U.S. Small-Mid Portfolio (NYSEARCA: PDN).

PDN tracks the FTSE RAFI Developed Markets ex-U.S. Mid-Small 1500 Index, providing investors with exposure to nearly 1,500 mid- and small-cap ex-US developed markets stocks. To be precise, about 15% of the ETF’s holdings are classified as large-caps.

PDN’s index “is designed to track the performance of small and mid capitalization equities of companies domiciled in developed international markets (excluding the US), selected based on the following four fundamental measures of firm size: book value, cash flow, sales and dividends. The equities with the highest fundamental strength are weighted according to their fundamental scores,” according to PowerShares.

Returns indicate PDN’s strategy works. The ETF is up more than 23% year-to-date and hit an all-time on Thursday. Nearly two-thirds of PDN’s holdings are classified as mid-caps, which can provide an advantage for investors over the long-term.

Middle capitalization stocks, or sometimes referred to as the market’s sweet spot, could help investors achieve improved risk-adjusted returns. Mid-cap companies are slightly more diversified than their small-cap peers, which allows many mid-sized companies to generate more consistent revenue and cash flow and provide more stable stock prices. Additionally, they are not so big that their size would slow down growth.