Investors frustrated with the laggard performances turned in by U.S. small-caps and the related exchange-traded funds this year
have been able to that frustration into profits with international small-cap ETFs.
That has not meant taking on excessive risk, either. The iShares MSCI EAFE Small-Cap ETF (NYSE: SCZ) is higher by almost 20 percent year to date, well ahead of the 2.6-percent
returned by the Russell 2000 Index.
Not only is SCZ proving to be a superior alternative to U.S. small-caps this year, but historical data indicate the fund has
some advantages over the MSCI EAFE Index, which is heavy on large-cap developed market ex-U.S. stocks.
The Differences Matter
Over the long term, SCZ can also be a valid alternative to funds that track the MSCI EAFE Index. Although that benchmark is one
of the most widely watched gauges of developed market equities outside the U.S., it has some flaws, including an emphasis on larger
companies and geographic concentration risk.
“To start with, the diversification of the MSCI EAFE Index was compromised in the late 1980s, with 60 percent of its portfolio
dedicated to Japanese stocks following their strong rally in that decade,” said Morningstar in a recent note. “As a result of this Japan stock bias, the
category-relative performance of the index went from first to worst in a short span when the Japanese stock market crashed in the
early 1990s.”
Japan looms large in the large-cap MSCI EAFE Index and SCZ, but SCZ's three largest countries combine for 45 percent of that
ETF's weight compared to over half in the large-cap benchmark. There are also sector-level differences. The MSCI EAFE Index's three
largest sector weights combine for over 48 percent while SCZ's three biggest sector allocations combine for 41 percent.
Enviable Track Record
“The result of diversifying across a broader selection of countries and the inclusion of small-cap stocks not only improves
category relative performance, but also enhances absolute and risk-adjusted returns,” said Morningstar.
SCZ's tale of the tape is impressive. Over the past three years, the ETF is up nearly 26 percent compared to an almost 9 percent
gain for the MSCI EAFE Index. SCZ has also been less volatile than its large-cap counterpart over that period and during that
three-year stretch, SCZ was 220 basis points less volatile than the Russell 2000 Index.
Related Links:
Know This Nat Gas
ETF
Traders
Love These Tech ETFs
© 2017 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.