6 Reasons to Invest in Emerging Market Small Caps

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Includes: BRF, EWX, HAO-OLD, LATM, SCIF
by: David Hunkar

One of the asset classes that investors often overlook is international small caps. This is understandable since investing in any small cap is often considered to be extremely risky because of the volatility and other risks associated with them.

Compared to domestic small caps, foreign small caps pose additional risks such as the lack of liquidity, access to information, etc. However investors would be missing some great opportunities if they completely ignore foreign small caps.

Emerging market (EM) small-cap stocks offer many excellent opportunities for investors willing to explore this area of the market. A recent research report by Pyramis Global Advisors makes some compelling arguments to invest in this class of equities.

Some of the reasons for investing in EM small cap stocks based on the report are noted below:

  • The emergence of a robust middle-class in emerging markets may boost the return on EM small-caps just like the large-caps. For example, while China’s middle-class of 157 million is lower than the size of the US middle-class population, China has the largest cell phone market in the world with a total subscriber base of 700 million.
  • The strong economic growth projected in EM countries will benefit EM small-caps.
  • Historically EM Small-caps have had high returns compared to other asset classes as shown below: (Click to enlarge)

  • Unlike large-cap companies small-cap companies are mostly focused on the local markets which are projected to experience significant growth.
  • Due to the rapid economic growth in emerging markets, demand for consumer products and services will increase exponentially. Some examples include the demand for tires in India due to the strong growth in automobile sales, insurance business in China, property companies in Brazil, etc.
  • EM small-caps have a 12% lower co-relation with the S&P 500.

Many ETFs are available that cover the small-cap space in emerging markets. The following are some of them:

SPDR S&P Emerging Markets Small Cap ETF (NYSEARCA:EWX)
Market Vectors Brazil Small-Cap ETF (NYSEARCA:BRF)
Claymore/AlphaShares China Small Cap Index ETF (NYSEARCA:HAO-OLD)
India Small-Cap Index ETF (NYSEARCA:SCIF)
Latin America Small-Cap Index ETF (NYSEARCA:LATM)

Disclosure: None