The ETF industry continues to grow by leaps and bounds as investors embrace the numerous benefits associated with the exchange-traded product structure. Recent volatility in the markets hasn’t stopped the industry from expanding as issuers continue to beef up their product pipelines and roll out first-to-market products. In a slew of SEC filings, iShares, the largest ETF issuer by total assets, laid out plans for ramping up its suite of country-specific ETFs.
The industry giant has laid the groundwork for several different products linked to small cap indexes including the following ETFs:
- MSCI South Korea Small Cap Index Fund
- MSCI Taiwan Small Cap Index Fund
- MSCI Hong Kong Small Cap Index Fund
- MSCI Germany Small Cap Index Fund
- MSCI Canada Small Cap Index Fund
- MSCI Australia Small Cap Index Fund
- MSCI Singapore Small Cap Index Fund
- MSCI United Kingdom Small Cap Index Fund
Most of the proposed products would join existing funds offering exposure to small cap stocks in those markets; IndexIQ’s lineup already includes funds that target small cap stocks in South Korea (SKOR), Taiwan (TWON), Hong Kong (HKK), Canada (CNDA), and Australia (KROO), while Van Eck offers a small cap Germany product (GERJ). Meanwhile there may be less competition in the UK and Singapore markets as the only pure play funds tracking these spaces are dominated by holdings in large cap stocks but they are pretty popular with investors; EWU has about $1.2 billion in assets while EWS has about $1.5 billion [see Guide To Small Cap International ETFs].
Small Cap Appeal
The first generation of international stock ETFs are dominated by large cap companies, appealing to investors seeking “safer” exposure across foreign equity markets. However, this approach is susceptible to several drawbacks and nuances that make it less than ideal for those seeking well-rounded exposure to international markets.
When it comes to international exposure, small cap companies may be more of a “pure play” on the local economy. First generation country ETFs are biased towards large cap, multinational corporations that generate revenues around the globe. Moreover, baskets of large cap stocks tend to feature a disproportionately high weighting towards energy and financial companies, while underweighting the consumer goods and services sectors [see BRIC ETF Investing: Small Cap Edition]. Additionally, many large cap funds are not necessarily impacted by local trends in the economies of the country they invest in. Those who are bullish on a country’s economic outlook ought to consider investing in the small cap corner of its equity market, seeing as how smaller firms are generally more dependent on local consumption patterns, demographic trends, and changes in the local economy.
Investors should keep in mind that small cap stocks tend to have smaller customer bases, shorter operating histories, and less cash on hand, and thus they are often time far more volatile than their large cap counterparts. But because this asset class possess greater growth potential, small caps in turn also carry potential for unparalleled returns. Small cap equities can also serve as diversifying agents while also potentially helping to improve a portfolio’s risk-adjusted returns in the long run. As such, it is perhaps more appropriate to think of small cap equity ETFs as complements to large cap funds, rather than substitutes.
Disclosure: No positions at time of writing.
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