ETF investors should look to developed or emerging small caps excluding the US as domestic smaller companies are not benefitting from foreign growth and dollar weakness like their larger counterparts.
TrackInsight data illustrates this trend more clearly.
US small caps hurt global returns
Year to date, US small caps are down more than 7%, and this has affected the global performance of the asset class. Small caps around the world are down around 5.3%, but have still seen positive inflows of more than $13 billion. Just in developed countries, small companies are down 5.8%.
Analysts at Jefferies say US small caps will see a flat third quarter at best, with projected earnings expected to fall 2.5%.
But take out US exposure and small cap returns tell a more positive story.
Ex-US exposure reaps rewards
Emerging markets small caps have risen almost 11% year to date, and gathered $439 million. And developed world small caps have also shown positive gains of 6.6% and $1.7 billion over the same period.
For investors looking for a more conservative option on small caps abroad, they might consider developed market funds.
DBES is conservative option
The Deutsche X-trackers MSCI EAFE Small Cap Hedged Equity ETF (DBES) tracks the MSCI EAFE Small Cap U.S. Dollar Hedged Index and offers investors “purer access to small-cap developed market equities while mitigating exposure to fluctuations between the value of the US dollar and select foreign currencies”, according to Deutsche Bank.
The fund, which focuses on companies in Europe, Australasia and the Far East, is up nearly 18% year to date, versus 12% for the bellwether S&P 500 or 5% for the popular Russell 2000 Index.
If the US dollar strengthens against foreign currencies, DBES is set to outperform non-currency hedged alternative funds. It is also diversified with almost 970 stocks, with 39% exposure in industrial and consumer discretionary stocks.
Japanese exposure in the fund helps performance, as Japan boasts some of the world’s best-performing small caps. The fund costs 0.45% per year.
Currency hedged alternatives
There are two other currency hedged options if investors are keen to mitigate FX risk. The iShares Currency Hedged MSCI EAFE Small Cap ETF (HSCZ) costs 0.43%. It is up more than 14% since 1 January.
The WisdomTree Dynamic Currency Hedged International SmallCap Equity Fund (DDLS) also costs 0.43% and has gained more than 16.5% in the same timeframe.