Whether you’re an active investor or swear by index funds, you can’t ignore the long-term outperformance of small-cap firms. This market anomaly has been around since the 1980’s. And it turns out that the small firm return premium carries over into the international stock market as well. With the recent choppy investment market environment, small-cap international funds deserve a closer look.
With lower correlation to U.S. large-cap equities and higher 10-year returns than U.S. or international large-cap stocks, small-cap international stocks are enticing.
Recent 10-year data explains the allure of this sometimes overlooked asset class. From July 1996 through September 2017, the Russell Global ex-U.S. Small Cap index returned 8.41% during each rolling monthly 10-year return. This performance beat the Russell 2000 large-cap U.S. index return of 6.98%. Now compare the Russell global ex-U.S. Small Cap index with the broader Russell Global ex-U.S. large cap’s return of 5.82% and you’ll find a 2.5% benefit for the global small caps over their international large-cap peers, according to a RoyceFunds research report.
If managing your own small-cap fund portfolio isn’t how you like to spend your time, there are ways to capture the small-cap investment returns and get investment management. Both Betterment and M1 Finance offer small-cap international investment options. Betterment gives exposure to the small-cap value sphere and M1 allows you to pick your international small-cap stocks and funds and then manages them for you, for free.
For self-directed investors ready to dive in, here’s a sample of five small-cap international funds. You can go broad or narrow your focus by style, such as growth, value or factor based. Just be sure, you’re getting the exposure you expect, as some international global funds include U.S. companies as well.
Small-Cap International Funds: Vanguard FTSE All-World ex-US Small-Cap ETF (VSS)
Expense Ratio: 0.13%
Vanguard, founder of the index fund, offers a plain vanilla, passively managed, market-cap-weighted small-cap international exchange traded fund, Vanguard FTSE All-Wld ex-US SmCp ETF (NYSEARCA:VSS). Also available as a mutual fund (MUTF:VFSVX) this fund tracks the performance of the FTSE Global Small Cap ex-US index. It’s a one-stop-shop for international small-cap exposure with access to both developed and emerging market non-U.S. firms.
The fund holds 3,610 stocks and charges 0.13% of assets under management. This diversified fund spans the small cap universe with 20% in emerging markets, 37% in Europe, 29% in the Pacific, 0.40% in the Middle East and the remainder in North America.
Small-Cap International Funds: iShares Edge MSCI Multifactor Intl Small-Cap ETF (ISCF)
Expense Ratio: 0.4%
Not your typical index fund, the iShares Edge MSCI Multifactor Intl Small-Cap ETF (NYSEARCA:ISCF) mirrors an index that focuses on four investment factors; value, quality, momentum and small size. The fund uses factors that have outperformed the market, but with similar market risk.
Launched in April 2015, this Blackrock fund charges a reasonable 0.4% expense ratio, holds 603 stocks and seeks to beat the market returns.
Top sectors for ISCF were industrials at 21% and technology at 16%.
Small-Cap International Funds: Schwab International Small-Cap Equity ETF (SCHC)
Expense Ratio: 0.12%
Schwab’s foray into small-cap index fund investing, the Schwab International Small–Cap Equity ETF (NYSEARCA:SCHC), strives to capture the total return of the FTSE Developed Small Cap ex U.S. Liquid Index.
This index fund owns 2,020 securities and is a handy ETF that captures international developed market small-cap stocks, outside the U.S. The fund is 10 years old and is cheap to own with a 0.12% expense ratio.
Half of the fund’s holdings are in Japanese, Canadian and United Kingdom companies.
Small-Cap International Funds: Schwab Fundamental International Small Company ETF (FNDC)
Expense Ratio: 0.39%
Like the iShares multifactor international small-cap fund, the Schwab Fundamental International Small Company ETF (NYSEARCA:FNDC) strives to beat the traditional indexes with a fundamental bent. The fund weights the following factors over a set period of time; adjusted sales, retained operating cash flow and dividends plus buybacks. Similar to Schwab’s SCHC, this fund selects its equities from the holdings in the Russell Developed ex U.S. Index.
The biggest region represented in the FNDC ETF is Japan, at over a third of the fund.
It has a 0.39% expense ratio and 50% of it’s holdings are concentrated in the industrial, consumer discretionary and financial industries.
Small-Cap International Funds: Fidelity® International Small-Cap Opportunities (FOPAX)
Expense Ratio: 1.43%
For investors seeking a small-cap growth, actively managed fund, consider the Fidelity International Small-Cap Opportunities (MUTF:FOPAX). The fund’s returns beat its MSCI EAFE Sm Cap (Net MA) benchmark in the one-, three-, five- and 10-year periods. With 35% of its holdings concentrated in Japan, the fund’s March 2018 top equities include; Spectris PLC, Azbil Corp, Spirax-Sarco Engineering PLC, Obic Co Ltd and Dechra Pharmaceuticals PLC. The 1.43% expense ratio reflects the higher cost of active management and stock picking of the 136 holdings.
There is a minimum investment of $2,500.
These are a sample of the scores of international small-cap funds. Depending upon your risk profile, time horizon and investing style you can choose hedged funds, dividend factor small cap international funds and many more varieties. Just don’t forget about the important, small cap international stock universe. Invest in this often overlooked arena and you’ll improve diversification and possibly portfolio returns as well.
Barbara A. Friedberg, MBA, MS is a veteran portfolio manager, expert investor, and former university finance instructor. She is editor/author of Personal Finance; An Encyclopedia of Modern Money Management and two additional money books. She is CEO of Robo-Advisor Pros.com, a robo-advisor review and information website. Additionally, Friedberg is publisher of the well-regarded investment website Barbara Friedberg Personal Finance.com. Follow her on twitter @barbfriedberg and @roboadvisorpros. As of this writing, she owns shares of Vanguard’s FTSE All-World ex-US Small-Cap ETF (VSS).
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