This article explores the state of global small-cap stock investment and identifies some of the best funds to build exposure in your portfolio.
Why Invest in Small-Cap Stocks?
Small-cap stocks are generally defined as companies listed on the stock exchange with a market capitalization of less than $2 billion. Although this number may not seem small, the odds are that your portfolio is primarily composed of large-cap stocks with values exceeding $10 billion. This disparity is due to the fact that most funds track indices weighted by market capitalization, thus large companies attract the largest share in the portfolio.
The problem with only investing in large-cap stocks is that they tend to have a high correlation with the overall market – they are the market itself. By diversifying into assets with lower correlations, investors can offset declines in the general market and reduce the volatility of their overall portfolio. This means that their portfolio may not decline as much during a bear market, but it may retain its value relatively during a bull market.
There are several benefits to investing in small-cap stocks, including:
1. Diversification: Small-cap stocks are not significantly correlated with the general market, making them a great way to diversify a portfolio. For example, the correlation of the Schwab U.S. Small-Cap ETF (SCHA) with the S&P 500 is only 0.877 compared to the correlation of the Schwab U.S. Large-Cap ETF (SCHX) which is 0.998.
2. Better Returns: Some studies have shown that small-cap stocks outperform large-cap stocks over the long term. For example, the study “The Cross-Section of Expected Stock Returns” published in the Journal of Finance found that small-cap stocks outperform large-cap stocks and value stocks over the long term.
Global small-cap stocks also enjoy added benefits from geographical diversity in markets outside the United States. This can help investors mitigate fluctuations caused by the U.S. economic cycle and improve the risk-adjusted return. Investing in international securities also makes sense when considering that U.S. stocks represent less than half the size of the global equity market.
Important Considerations
Small-cap stocks may not be suitable for all investor portfolios. For instance, investors nearing retirement may wish to invest in fixed-income bonds or high-value stocks to reduce volatility, which means global small-cap stocks may not be appropriate for their portfolios. Other investors with a shorter time frame may also want to avoid small-cap stocks as they tend to be more volatile and may take longer to achieve higher returns.
For investors interested in global small-cap stocks, there are many different options in terms of funds. While many small-cap indices operate in the same way as traditional stock indices, there are new smart funds offering unique understanding strategies that can be appealing to investors. A focus on fundamentals and prioritizing small companies with compelling fundamentals to mitigate risks can be a great example.
Finally, investors should carefully consider the cost ratios and management team before investing in a specific fund. Cost ratios can significantly impact long-term returns, and small-cap stock expenses are higher than those of large-cap stocks. Smart beta strategies tend to have the highest cost ratios, meaning that investors should ensure that the additional cost provides them with sufficient benefits.
Best Small-Cap Funds
Exchange-traded funds (ETFs) and mutual funds are the easiest way to add exposure to small-cap stocks in your portfolio, especially when it comes to international stocks. Purchasing individual stocks entails a significant amount of research and requires periodic rebalancing to keep risk factors under control. ETF funds handle stock selection and daily rebalancing for a small cost ratio that is much lower than mutual funds.
The largest
International small-cap stocks include:
- iShares MSCI EAFE Small-Cap ETF (SCZ)
- Vanguard FTSE All-World ex-US Small-Cap ETF (VSS)
- WisdomTree International Small-Cap Dividend Fund (DLS)
- Schwab International Small-Cap Equity ETF (SCHC)
- Schwab Fundamental International Small Company Index ETF (FNDC)
- SPDR S&P International Small-Cap ETF (GWX)
- iShares FactorSelect MSCI International Small-Cap ETF (ISCF)
For investors who prefer mutual funds, there are also several options available:
- Oppenheimer International Small-Mid Company Fund (OSMAX)
- T. Rowe Price International Discovery Fund (PRIDX)
- Fidelity® Series International Small-Cap (FFSTX)
- Wasatch International Opportunities Fund (WAIOX)
- MFS International New Discovery Fund (MWNIX)
- Oberwise International Opportunities Fund (OBIOX)
- Fidelity® International Small-Cap Opportunities (FOPAX)
Conclusion
Global small-cap stocks are a great way to diversify any portfolio. In addition to geographical diversity, small-cap stocks tend to be less correlated with the broader market and can help smooth returns. The funds mentioned in this article provide an easy way for investors to access these assets, but it is important to carefully consider costs before investing in them.
The Balance does not provide tax, investment, or financial services and does not offer advice. Information is provided without regard to the investment objectives or risk tolerance or financial circumstances of any particular investor and may not be suitable for all investors. Past performance is not indicative of future results. Investing involves risks including the risk of loss of principal.
Source: https://www.thebalancemoney.com/best-international-small-cap-funds-4137225
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