Emerging market exchange traded funds that focus on small-cap stocks have more growth potential than large-caps. Although these smaller counterparts are a bit riskier, they can add more exposure to a portfolio.
"International equities provide diversification benefits to U.S. investors through exposure to different economies and currencies. Generally speaking, small-cap funds can provide better diversification benefits as these companies are more exposed to local economies and customers through heavier weightings in consumer, transportation, and construction firms, as opposed to a fund that tracks a broad emerging-markets index, which has heavy weightings in multinational mining, technology, and energy firms," Patricia Oey wrote in a recent Morningstar analysis.
The developed world is facing a slowdown in growth, while emerging economies are benefiting from long term drivers of growth. Areas that are expanding include new infrastructure construction, higher-value exports, and rising domestic consumption. Furthermore, the governments in developing countries have more leeway for adjusting monetary and fiscal policies to facilitate growth, reports Oey.
The ongoing Eurozone crisis is a threat the continued growth of up-and-coming economies. Most of the world is watching to see if Greece will step out of the Eurozone and if Spain's economy can survive the latest bank downgrades by Moodys. A slowdown in global growth will impact emerging markets, due to their export-focused economies.
Large-cap focused ETFs tend to have high concentrations in a few sectors, limiting portfolio exposure to a few slices of an economy. Small-cap ETFs often have a more spread out portfolio, which usually includes more assets in consumer or industrial sectors.
Take note, small-cap shares and ETFs are riskier than large-caps and investors need to be able to tolerate some volatility. However, with the higher risk rate also comes a better reward.
- SPDR S&P Emerging Small Cap ETF (NYSEARCA:EWX)
- WisdomTree Emerging Markets Small Cap Dividend Fund (NYSEARCA:DGS)
- iShares MSCI Emerging Markets Small Cap Index Fund (NYSEARCA:EEMS)
Tisha Guerrero contributed to this article.