Small-Cap Relief In Emerging Markets

Sick of hearing about U.S. small caps and the relevant exchange-traded funds lagging their large-cap counterparts? It is understandable if investors feel that way, but it is concerning that the Russell 2000 Index fell 1.2 percent last week while the S&P 500 nudged modestly higher.

As has been widely documented through 2017, international small-cap ETFs have been much better bets than their U.S. equivalents. That includes emerging markets small-cap ETFs. An asset class that is believed to be exceptionally volatile is delivering in significant fashion for investors. Just look at the First Trust Emerging Markets Small Cap AlphaDEX Fund FEMS.

FEMS is up 32.1 percent year to date, meaning the 2017 gains offered by the Russell 2000 Index and the S&P SmallCap 600 Index could be combined then multiplied by five and still not exceed the returns offered by FEMS this year.

What's In The FEMS Mix

FEMS follows the NASDAQ AlphaDEX Emerging Markets Small Cap Index, which is a smart beta approach to smaller emerging markets equities. The ETF turned 5 years old earlier this year.

“To construct the Index, Nasdaq ranks the eligible stocks on growth factors including 3-, 6- and 12- month price appreciation, sales to price and one year sales growth, and separately on value factors including book value to price, cash flow to price and return on assets,” according to First Trust. “All stocks are ranked on the sum of ranks for the growth factors and, separately, all stocks are ranked on the sum of ranks for the value factors. A stock must have data for all growth and/or value factors to receive a rank for that style.”

Data suggest the FEMS methodology works. Since coming to market in February 2012, FEMS has returned 6.3 percent. While that is not spectacular, it does outpace the 2.8 percent returned by the MSCI Emerging Market Small-Cap Index over the same period.

Countries And Sectors

FEMS holds 205 stocks. At the geographic level, the ETF allocates nearly 30 percent of its weight to Taiwan, historically one of the least volatile emerging markets. China and Brazil combine for a quarter of the ETF's weight. Overall, small caps from 10 countries are found in FEMS.

FEMS is benefiting from the stellar performance of emerging markets technology names this year as that sector is over 20 percent of the ETF's weight. As a small-cap ETF, FEMS is likely to avoid state-controlled companies as highlighted by a mere 10-percent combined weight to the energy and financial services sectors.

Materials and real estate names combine nearly 31 percent of the ETF's roster while FEMS's consumer exposure is merely adequate at 14.6 percent.

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