VSS: Vanguard's FTSE All-World Ex-US Small-Cap ETF Provides Exposure To Stocks Most Investors Miss
Summary
- International Mid/Small-Cap stocks market value is 6% of the total world's equity market, but US investors' allocation is just 1.6% in mutual funds to this asset class.
- Since 1995, Small-Cap stocks are the best performers of the seven International classifications available on PortfolioVisualizer.
- History shows smaller stocks do well post-recession and international ones when the dollar is falling, so I am giving VSS a Bullish rating.
Introduction
US investors are underweight international stocks, even more so in the Small-Cap part of the market. So while the following chart shows that has been a wise investment decision since 1995, current valuation statistics and a weakening USD has me rating the Vanguard FTSE All-World ex-US Small-Cap ETF (NYSEARCA:VSS) as a Bullish investment choice at this time.
Source: portfoliovisualizer.com
So, the question then switches to what segment of the International market has done the best so at least US investors are getting better results for the funds they have/want invested overseas?
Source: portfoliovisualizer.com
Here we can see that Small-Cap stocks outperformed both Total-Cap Developed and Emerging Markets stocks. When compared to all seven international groupings PortfolioVisualizer has data for, again back to 1995, Small-Cap has best the CAGR, Sharpe & Sortino ratios, and next to lowest correlation to US stocks. One reason to own international stocks is to add assets with low correlation to the US equity market as that should lower an investor's overall portfolio risk.
Source: portfoliovisualizer.com
I tested to see if that low correlation does help decease the portfolio risk level, so I ran the following comparison. Here I assumed an investor would be adding International Small-Cap stocks to either an all US Large-Cap portfolio or an all-encompassing US equity portfolio.
Source: portfoliovisualizer.com
One thing the above data shows is adding Mid- and Small-Cap stocks would have benefited Large-Cap only US investors as the Vanguard 500 results trail the full US Market results. For investors currently focused on Large-Cap stocks, adding 5% of International Small-Cap stocks improved your CAGR slightly but with a little added risk. If you had added US Small-Cap, the benefit was even greater, but that concept is for another article. Adding international Small-Cap stocks to the diversified US portfolio hurt performance but risk reduction did occur.
One reason US investors should consider international stocks at this time is the trade-weight value of the USD is declining, which benefits international stocks.
Source: fred.stlouisfed.org
If you looked at the last time the dollar weaken (Jan'17-Jun'18), international Small-Cap outperformed both US Small-Cap and US Large-Cap stocks. A recent article by Ralph Wakerly entitled International Small-Cap Equities: Poised To Outperform mentioned the same phenomenon and other reasons investor should be considering these stocks in today's environment.
Examining the Vanguard FTSE All-World ex-US Small-Cap ETF
Data byThe first place to start with any index-based ETF is with the index they invest against. VSS uses the FTSE Global Small Cap ex US Index, which FTSE describes as:
The FTSE Global Small Cap ex US Index is a market-capitalization weighted index representing the performance of Small cap stocks in Developed and Emerging markets excluding the US. The index is derived from the FTSE Global Equity Index Series (GEIS), which covers 98% of the world's investable market capitalization.
Source: Index PDF
The index dates back to 1993 and it rebalances each March and September. Screening rules include Free-Float Shares and trading liquidity. Currently, there are 48 countries included in the index. The following chart allows you to see the effect of excluding US Small-Cap stocks.
Source: Index PDF
With that background, let us explore VSS, which Seeking Alpha describes as:
Vanguard FTSE All-World ex-US Small-Cap ETF is an exchange traded fund launched and managed by The Vanguard Group, Inc. The fund invests in public equity markets of global ex-US region. It invests in stocks of companies operating across diversified sectors. It invests in growth and value stocks of small-cap companies. The fund seeks to track the performance of the FTSE Global Small Cap ex US Index. VSS was launched in April, 2009.
Source: seekingalpha.com
VSS holds $6.3b in AUM with Vanguard charging 11bps in fees. Holdings total over 3900 stocks with "dividends" paid quarterly, which have varied from pennies to $2 since 2015.
Source: seekingalpha.com
We will now look at its holdings from several angles, the first being size. One thing I have noticed about most size-focused ETFs, they all drift outside that mandate and that varies even for VSS based on whose definition of size is used.
Source: morningstar.com
Since there are several ETFs that focus on International Small-Cap, I chose to compare VSS against their category, and not the index. The first being country.
Source: morningstar.com
This is useful when deciding which ETF to invest in. If you believe Japan is a better investment choice than Canada, let's say, you would want an ETF that isn't so underweight in Japan and overweight Canada. If we look at Regions, we notice VSS is vastly overweight EM countries. This is partially due, I believe, to the fact other ETFs use indices that exclude EM countries, such as SCZ.
Source: morningstar.com
Compared to the category, VSS is not vastly over/under weight in any sector. Of course, that will vary when compared to any individual ETF.
Source: morningstar.com
Not being one that analyzes foreign stocks, other than Blackberry (I use to have one of those!), none of the names mean anything to me. With over 3900 stocks, no one stock or even small group exploding up or down will drastically affect this ETF's performance, so that is not critical when I review such an ETF.
Portfolio Strategy
Source: Photo
The invention of low-cost ETFs has made diversified investing much easier for we investors who want decent returns but don't have the skill and/or time to pick individual stocks. The downside is such investors, unless the pick winning narrow-focused ETFs, like QQQ, only hope to match market performance. On the plus side, ETFs allow us to invest in markets where finding good, individual stocks is not only tough, but possibly nearly impossible to invest in, such as most "third world" countries.
So, for us, the task is finding the "best" ETF for the market segment exposure we are after. If you need names of other funds that invest the same, use the Peers function of Seeking Alpha.
Source: seekingalpha.com
It will include the one you know and up to five other funds. The above chart is a small sample of the basic data provided. Price performance data is another set provided. SCZ will show better return numbers, so why not suggest that one? That is when it is important to understand each fund's index of choice. SCZ uses one that excludes EM Small-Cap stocks so investors wanting total international exposure would pick VSS over SCZ. SeekingAlpha also provides screening tools that will help find other funds in your search area or as a means of starting one from scratch. The Premium services provides 8 pre-built screens that show Top rated securities in individual market segments.
There are several sites that allow you to find every fund that measures itself against the same index; one of the better ones is ETFdb.com Indexes. It lists VSS as the only ETF following the index it uses.
A site I mention often in my ETF articles is ETF Research Center. This site allows you to compare the holdings overlap between two ETFs and how that effects their sector allocations. In addition, there are charts showing AUM, money flow, and short interest of the ETF.
Lastly, PortfolioVisualizer provides data beyond performance and basic risk metrics. They have tabs that expand those metrics, plus others for drawdowns and correlations. This site would be used after you narrowed down your list of possible funds to the finalist.
The point of all of that is to emphasize that after picking the area you want to add exposure to, for this article it was International Small-Cap, you then need to understand what each fund in that arena provides in terms of coverage, performance, and risks. So even those of us you rely heavily on ETFs and other funds, we still have our due diligence to perform!
Readers with a sharp eye will notice I own SCZ, not VSS. I am Bullish on both and bought SCZ when EM countries were not faring well in any of their ETFs. Ralph Wakerly recently covered this market segment, except for VSS, in his iscf-captures-best-opportunity-in-international-small-caps-in-20-years article.
This article was written by
I have both a BS and MBA in Finance. I have been individual investor since the early 1980s and have a seven-figure portfolio. I was a data analyst for a pension manager for thirty years until I retired July of 2019. My initial articles related to my experience in prepping for and being in retirement. Now I will comment on our holdings in our various accounts. Most holdings are in CEFs, ETFs, some BDCs and a few REITs. I write Put options for income generation. Contributing author for Hoya Capital Income Builder.
Analyst’s Disclosure: I am/we are long SCZ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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