Emerging Markets Small-Caps ETF Soars Above Large-Cap Rivals

The proverbial they say it has been a bad year for emerging markets equities and ETFs. They are correct, but only to a limited extent as it has been the largest developing markets and the corresponding ETFs that have been real laggards.

By focusing on large-cap emerging markets stocks and some of the ETFs that hold those shares, plenty of investors would be lead to believe 2013 has been a dreadful year in which to be long developing markets. They may not know that the opposite is true of emerging markets small-caps. The WisdomTree Emerging Markets SmallCap Dividend Fund (NYSE:DGS) proves as much.

The WisdomTree Emerging Markets SmallCap Dividend Fund's underlying index, the WisdomTree Emerging Markets SmallCap Dividend Index (WMS), offers exposure to all 10 major sectors (financial services, industrials, discretionary, etc.), and in all 10 cases the index has outpaced large-cap an equivalent large-cap index.

For example, telecommunications shares in the WisdomTree Emerging Markets SmallCap Dividend Index were up 16 percent through April 10 compared to 4.3 percent loss for the same sector in the MSCI Emerging Markets Index, according to WisdomTree data.

Consumer staples and health care names in the small-cap index sported double-digit returns while the large-cap equivalents were only modestly higher. Large-cap emerging markets industrials, materials and technology names featured in the MSCI Emerging Markets Index traded lower, but those sectors in the WisdomTree Emerging Markets SmallCap Dividend Index rose.

"The mid- and small-cap stocks in the WisdomTree Emerging Markets SmallCap Dividend Index have outperformed their large-cap peers, represented by the MSCI Emerging Market Index, in all 10 sectors," said WisdomTree Research Director Jeremy Schwartz in a research note. "Every sector in the WisdomTree Index has posted a positive return year-to-date, while fewer than half the sectors of the MSCI Emerging Markets Index saw positive performance over the same period."

The $1.55 billion WisdomTree Emerging Markets SmallCap Dividend Fund allocates a combined 42 percent of its weight to financial services and industrial names with consumer discretionary, materials and technology also receiving double-digit allocations.

With developing world small-caps performing better than many expected, DGS is higher by six percent year-to-date while some of the marquee large-cap emerging markets ETFs are in the red. Surprisingly, DGS sports volatility of just 11.3 percent this year, making it about 200 basis points less volatile than two of its most popular large-cap rivals.

DGS has been able to deliver for investors this year due to another reason: Country mix. Yes, laggard markets such as South Korea, South Africa and China are featured within the fund. However, Thailand, Malaysia and Turkey combine for over 28 percent of the ETF's weight. Throw in Indonesia and the Philippines and that means some of this year's better emerging markets account for over 35 percent of DGS' weight.

"The positive economic growth in emerging market economies is translating into a growing class of citizens with more discretionary income," said Schwartz. "We expect this trend will continue in emerging market countries, and it is important to focus on this new class of emerging consumers. Large-cap companies are important to consider, but many are concentrated in the energy and financial sectors and are more dependent on global growth. To capitalize on this growing emerging consumer, we think one strategy is a focus on small-cap companies that are often more dependent on the growth from their own country and citizens."

DGS, which debuted in October 2007, has a 30-day SEC yield of 2.57 percent and annual expense ratio of 0.64 percent.

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