Small-cap stocks are often thought to be a volatile asset class with investors believing that is particularly true of international small-caps. However, international small-caps are easily outperforming their U.S. counterparts this year, indicating investors may want to consider the risk/reward paradigm offered by ex-US smaller stocks.
The Deutsche X-trackers MSCI EAFE Small Cap Hedged Equity ETF (BATS: DBES) is an exchange traded fund to consider. DBES “seeks investment results that correspond generally to the performance, before fees and expenses, of the MSCI EAFE Small Cap U.S. Dollar Hedged Index. DBES offers investors purer access to small-cap developed market equities while mitigating exposure to fluctuations between the value of the U.S. dollar and select foreign currencies,” according to Deutsche Asset Management.
DBES is up 20% year-to-date, or more than triple the returns posted by the US-focused Russell 2000 Index. Making the year-to-date performance of DBES all the more impressive is that the ETF is a currency hedged product, meaning it could be vulnerable to the weaker dollar, but that clearly has not been the case in 2017.
“Small companies tend to lack the global scale of their large-cap counterparts, with a large portion of their revenue coming from their local economy,” said Morningstar. “This is true both in the U.S. and abroad, and makes these firms more susceptible to local economic conditions and policies. They are less likely to have competitive advantages than larger companies. In general, small-caps should be more volatile than large-caps, and may provide a higher rate of return as compensation.”
Related: A Smart ETF Approach to International Dividends
DBES holds nearly 1,000, about 39% of which hail from the industrial and consumer discretionary sectors. Confirming its highly cyclical tilt, the ETF devotes over 22% of its combined weight to financial services and technology names.
“Investors that expect these stocks to outperform should take a conservative perspective regarding the magnitude of the expected excess return. While small-cap stocks can outperform, their strong performance over the course of the past 16 years probably isn’t representative of what to expect going forward,” according to Morningstar.
DBES is conservatively positioned at the geographic level and in the ETF’s just over two years on the market, its volatility traits compare favorably with those found on U.S. small-cap benchmarks.
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