Many investors feel pretty brave when they venture into emerging-market stocks, which can be relatively volatile. But for the most part, the stocks they are betting on are from fairly large, well-established companies. There is another, even more daring way to invest in emerging markets—small-cap stocks. Their share prices plunged nearly 60% in 2008, on average…bounced back 114% the next year…then fell another 27% in 2011.
So why consider these companies at all? They tend to grow much faster than big companies, which helps boost their stock prices. Among emerging-market stocks, small-caps beat large-caps by an average of four percentage points annually over the past decade. And they tend to be local retail and service businesses closely linked to the booming domestic economies in developing nations, whereas the large-caps often are global energy or materials exporters with earnings tied to the slower-growth developed world.
There are a handful of actively managed emerging-market small-cap mutual funds, including the recently launched Oppenheimer Emerging Markets Innovators Fund (EMIRX), but I prefer to use lower-cost, broadly diversified exchange-traded funds…
SPDR S&P Emerging Markets Small Cap ETF (EWX) invests in about 700 stocks, allocates no more than 0.6% to any one stock and is heavy in consumer-oriented businesses such as China Dongxiang Group, which makes popular sportswear.
WisdomTree Emerging Markets Small Cap Dividend ETF (DGS), the oldest emerging-market small-cap ETF, invests in about 540 dividend-paying stocks and had a recent yield of 2.5%. It is more conservative and less volatile than the SPDR ETF.