The Right Way to Get Involved with Emerging Markets

This year, advisors are likely thinking it's a quixotic endeavor to bring up the same old emerging markets strategies to clients.

Due to the Chinese Community Party's (CCP) all gas no breaks approach to regulation, Chinese stocks are tumbling and, well, that's a problem for the most basic, cost-efficient emerging markets strategies so many clients love.

The MSCI Emerging Markets Index is down 2.57% year-to-date and much of that dour showing can be blamed on China as Chinese equities account for 33.54% of the index's weight – more than double the weight assigned to Taiwan, the second-largest country exposure.

What's interesting about the plight of emerging markets equities this year is that it's a mostly large-cap phenomenon. For example, the median market capitalization in the Vanguard FTSE Emerging Markets ETF (NYSEARCA:VWO) – the largest emerging markets exchange traded fund – is $24.1 billion. The fund devotes 36.8% of its weight to China.

The Small-Cap Surprise

This appears to go against conventional wisdom, but weakness in large-cap equities in developing economies isn't permeating small caps. Unfortunately, data confirm many investors are hardly paying attention to small caps in places like India and Russia, let alone are they allocating capital to such names.

“Investors can be forgiven for not realizing how well the asset class has done,” says WisdomTree asset allocation director Joseph Tenaglia. “There is currently $750 billion invested in U.S.-listed EM mutual funds and ETFs. Of those assets, less than 2% of all EM fund assets are in dedicated small-cap funds.”

In other words, the emerging markets small-cap opportunity is a prime avenue for advisors to add value for clients because many clients do want so exposure and they aren't the least bit familiar with small caps in this realms.

The group is easily accessible via the WisdomTree Emerging Markets SmallCap Dividend Fund (DGS). All that fund is doing this year is leaving the MSCI Emerging Markets Index and the Russell 2000 and S&P SmallCap 600 indexes in its wake.

That's not even all of the good news. DGS allocates just 13.44% of its weight, making that the fund's third-largest country weight. Taiwan and South Korea, two high-quality markets with significantly less regulatory angst, combine for over 41% of the fund's roster.

More Benefits

Emerging markets small-cap stocks offer more surprises that could be to clients' liking.

“EM small caps offer an organic way to gain access to the rise of the EM consumer theme, as most companies conduct the majority of their business within emerging markets As opposed to small-cap stocks in the developed world, EM small-cap dividend payers have historically been less volatile than their large-cap peers (DGS beta since inception vs. MSCI EM Index: 0.94),” adds Tenaglia. “Lastly, EM small caps are showing in today’s environment exactly how great of a diversifier they can be alongside large-cap EM companies.”

That's right. Emerging markets small caps offer clients MORE income and LESS volatility than large caps from the same regions. Those aren't trade-offs. Those are upgrades.

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