Guide to Small Cap Emerging Market ETFs - ETF News And Commentary

As domestic markets and European economies continue to sputter, growth in equities becomes harder to come by. In light of this, a look at quickly growing emerging markets could be ideal for some investors who have a higher risk tolerance at this time.

Not only do these nations have greater growth potential, but they often have lower levels of correlation with their developed market counterparts. Additionally, banking securities tend to be more focused at home than abroad, suggesting low levels of exposure to the European debt debacle as well (see more on ETFs at the Zacks ETF Center).

Luckily for investors, the ETF industry has made it extremely easy to play this slice of the market in a number of ways. There are now literally dozens of funds with either a regional focus, or even country specific products as well, that can give investors the opportunity to target with impressive ability any market segment that they so choose.

However, many large cap emerging market ETFs have high levels of concentration in just a few sectors. For example, two of the most popular funds in this segment, the SPDR S&P BRIC 40 ETF (BIK) and the iShares MSCI BRIC Index Fund (BKF), both have about half of their assets in two segments; financials and energy (read Top Three BRIC ETFs).

Obviously, this might not be ideal for many as it avoids a number of potentially high growth sectors and leaves a portfolio heavily dependent on just a few slices of an economy. In order to avoid this, investors could be better off looking at small cap emerging market ETFs instead.

ETFs in this segment focus on pint sized securities across the developing world, irrespective of sector, much like their large cap counterparts. Yet, unlike their large cap brethren, small caps often have a more spread out holding profile which usually includes more assets in consumer or industrial sectors (see Three Overlooked Emerging Market ETFs).

Additionally, small caps are often capable of higher levels of growth than large caps, a situation which can be especially important in the low growth world we find ourselves in today.

Yet with that being said, investors should note that these products can experience levels of volatility that can make large caps emerging stocks seem stable in comparison. Risk tolerance should be very high for those looking to make a play on this space as huge gains and losses can come in a very short period of time.

Nevertheless, for investors who are willing to juice up risk levels in hopes of achieving higher growth rates in a section of their portfolio, any of the four small cap emerging market ETFs we have highlighted below could be an excellent choice:

SPDR S&P Emerging Market Small Cap ETF (EWX)

This ETF tracks the S&P Emerging Markets Under USD2 Billion Index in order to give investors exposure to a basket of small cap stocks across various developing nations. The product has proven to be extremely popular with investors as just over $900 million is under management in the fund while trading volume is close to 105,000 shares a day.

Expenses in this ETF are moderate—low compared to some of the more specialized products in the space but high when you put it against the low cost options—at about 65 basis points a year. However, the decent annual yield of 1.65% should help to defray some of these costs for most investors.

In terms of a portfolio, EWX holds just over 810 securities in its basket and doesn’t allocate more than 0.8% to any one stock in particular. This suggests that the product is well diversified from an individual security perspective and is unlikely to face company specific risk (read Three Emerging Market ETFs To Limit BRIC Exposure).

The top three sectors are industrials, technology, and consumer cyclical, while energy and financials combine to make up just 12% of the total. For countries, Taiwan takes the top spot at 28% of assets, followed by 10% to China, 9%, in South Africa, and an 8% allocation to India.

WisdomTree Emerging Markets SmallCap Dividend Fund (DGS)

For a dividend-focused approach in the emerging market small cap ETF space, a closer look at DGS could be warranted. The fund tracks the WisdomTree Emerging Markets Small Cap Dividend Index which looks to focus on the bottom 10% of total market cap of the WisdomTree Emerging Markets Dividend Index, weighting firms based on annual cash dividends paid.

This produces a fund that pays out a solid dividend yield of roughly 3.5% a year, a good level considering the focus of the fund. Investors should also note that over $1 billion is under management in the fund and that both expenses are reasonable (0.63%) and volume is high (163,000 shares per day).

However, the product does hold fewer securities than many of its counterparts at just over 525 in total. Thanks to this, and the dividend weighting, the product does have a higher concentration in some of its top securities (see Top Three Emerging Market Consumer ETFs).

In terms of sectors, this small cap ETF is tilted towards industrials (20%), consumer cyclicals (14%), and technology (13%). However, financials and energy do combine to make up 15% of the fund although most of this allocation goes towards the financial space.

The country breakdown is similar to EWX as Taiwan (26%) takes the top spot although South Africa, and Thailand round out the top three.

iShares MSCI Emerging Markets Small Cap Index Fund (EEMS)

Market leader iShares’ entrant in the space is EEMS, a fund that has had some trouble gaining assets under management. AUM is still below $20 million in the fund promoting a weak level of volume and loose bid ask spreads. It also doesn’t help that the product had a higher expense ratio coming in at 69 basis points a year (see Frontier Market ETF Investing 101).

In terms of the portfolio, the ETF does hold over 630 stocks in its basket and does not put more than 0.6% in any single firm. Investors should also note that the fund has a significant holding in mid cap securities although small and micro caps do combine to make up about 45% of the portfolio.

Sector exposure in this fund is also tilted towards different sectors than what investors see in many large cap funds as consumer cyclical (17%), industrials (16%), and technology (15%), take the top three spots. Financials and energy, on the other hand, account for a modest 10% of the assets in this product, suggesting it could be a decent compliment to a large cap fund from this perspective.

Although the fund may have low volume, it truly shines in the country exposure department. Taiwan makes up less than 20% of the assets in this product, followed by a modest 15% allocation to South Korea and 8% allocations to both South Africa and India.

First Trust Emerging Markets Small Cap AlphaDEX Fund (FEMS)

The newest choice in the small cap emerging market ETF space is FEMS from First Trust. The product debuted in February and thus hasn’t really had a chance to build up assets yet. However, the cost could be prohibitive as it does charge investors 80 basis points a year in fees.

The added cost could be worth it for some, especially if you believe in the AlphaDEX methodology. This process takes a broad benchmark of emerging market stocks and ranks them by both growth and value characteristics.

Then, (roughly) top 200 stocks are then included in the fund, broken down by quintiles. The top quintiles receive a higher weight than the lower ranked ones, and stocks are equaled weighted within their five groups. This approach can potentially produce a value fund as the PE is currently below 8.5 on the holdings while the P/B is at 1.30 (read Five Emerging Market Infrastructure ETFs For The Coming Boom).

Nevertheless, the product does have a similar holdings breakdown in terms of sectors, as consumer cyclical firms account for 19% of assets while industrials, and basic materials round out the top three. It also appears to be a good way to avoid exposure to the sectors popular in large caps, as financials and energy combine to make up just 6% of assets.

Country exposure is once again tilted towards Taiwan at 21% of the total, although China is right behind at 20% of the holdings. Beyond these two, Hong Kong-based firms make up another 11% while Indonesia (10%) and Turkey (6%) round out the top five. Lastly, it should also be noted that South Korean firms are nowhere to be found in the fund at all.

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