What is an Emerging Market Small Cap ETF?
Looking for the epitome of a hot ticket investment? Consider looking into the opportunities offered by an emerging market small cap ETF. Many investors see these products as a bastion of untapped potential. They tick all the boxes for risk—namely small market capitalization in an emerging market. That said, they also offer the blanket security of an ETF. Diversified appropriately, there’s less risk and more opportunity than many investors realize in these exotic funds.
Before you run off to research emerging market ETFs with small cap influence, it’s important to know what you’re investing in. There aren’t many of these products out there. Getting familiar with what’s available will help you understand the scope of opportunities for an investment like this. There’s significant upside—but only if you understand the ramifications of global investments and small cap stocks.
Emerging Market Small Cap ETF Definition
By default, many emerging market companies are small cap—that’s what makes them “emerging.” ETFs that feature these companies tend to hone-in specifically on promising companies with potential to break into the mid cap range in the near future. The idea is to capitalize on the growing economies of other markets, which will naturally push up the value of smaller companies.
Most small cap ETFs focused on emerging markets aren’t sector-specific. Instead, they’re region-specific. You might find an ETF that focuses exclusively on African small cap companies or burgeoning companies in Southeast Asia. Some emerging market ETFs take a global approach, selecting companies in industries poised to break out by region.
Whatever the criteria for asset selection, emerging market small cap ETFs seek to capitalize on the growth potential of relatively unknown companies outside the U.S.
The Best Emerging Market Small Cap ETFs By Performance
Most investors aren’t looking outside U.S. markets for small cap investment opportunities. This is where the appeal of emerging market funds comes in. For those enticed by small caps, emerging market ETFs offer even more prolific opportunity for growth, since the economies themselves are growing. Overall, here’s a look at some of the best-performing small cap ETFs with an emerging market focus:
- WisdomTree Emerging Markets SmallCap Dividend Fund (DGS)
- Avantis International Small Cap Value ETF (AVDV)
- iShares MSCI Emerging Markets Small-Cap ETF (EEMS)
It’s important to realize that these funds aren’t immune to volatility. In fact, depending on the ETF, small cap emerging market funds can see a revolving door of assets under management. There are more factors to consider. More countries represented, more economies, etc. That said, there’s also opportunity to see strong growth from a few global companies that push the fund higher. In these funds, diversity is key.
What Constitutes an Emerging Market?
Emerging markets are countries with economies that are still developing. There are certain benchmarks that a country and its economy need to meet to “develop.” For example, a modern, industrial economy with a high standard of living. Typically, emerging markets still have a low-income, pre-industrialized economy. At a macro level, you might say that a developing economy is a producer economy and an established economy is a consumer economy.
Emerging markets occur throughout the world, in countries of all sizes. For example, recognized emerging markets in 2021 range from South Korea and India to Thailand and Morocco. Even China, the second largest economy in the world, is an emerging market. It all has to do with how the economy functions, not necessarily how big it is.
The appeal of emerging markets comes not only from their developmental status, but from their regionality. If the U.S. stock market has a bad streak, it doesn’t necessarily mean an emerging market ETF will suffer the same downturn—after all, these companies aren’t part of the same economy.
Are These ETFs Safe?
Emerging market funds tend to be relatively safe bets when properly hedged. On one side of the coin, they’re a hedge against turbulence in the U.S. economy. On the other side, they offer great exposure to not only small cap companies, but also foreign companies. The nature of an ETF safeguards against some of the volatility that comes from small cap investments. Meanwhile, the burgeoning economy of other nations primes these small companies for strong growth. It’s a win-win for investors.
Small cap, emerging market ETFs aren’t bulletproof. The double-whammy of foreign investment and small cap assets can hit hard if there are market headwinds. Investors are wise to make emerging market funds and small caps a smaller portion of their portfolio—unless their willing to shoulder more risk. As with most investment products, risk and reward balance each other. Savvy investors will take the time to vet the fund to see where its assets hail from, to better-attune themselves with any risk.
The Bottom Line on Emerging Market ETFs
Emerging market ETFs give investors exposure to companies they might not know about or understand. Small cap ETFs reduce the volatility of budding companies and maximize the potential of up-and-coming industries. Put them together and you get emerging market small cap ETFs: a powerful investment product with significant upside.
However, any opportunity for reward comes with risk. An ETF can only do so much to safeguard against instability. Investors in these ETFs need to understand the risk that comes with two extremely volatile markets. Bottom line? Emerging market small cap ETFs are best leveraged into part of a bigger, more stable investment strategy.
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