Small caps drive emerging market growth

Investors are increasing their exposure to the emerging markets by investing in small cap ETFs tracking the region, according to a report by Standard and Poor’s.

In the past six months, the iShares MSCI Emerging Markets Small Cap ETF has seen net assets shoot up from $70m to $212m. This compares to relatively sluggish growth of just $45m over the first year from its inception in March 2009.

S&P vice president of global equities Alka Banerjee says the last ten years have seen a big change in the transparency of small-cap companies in emerging markets. For example, almost all have adopted international accounting procedures.

While smaller companies get only limited exposure in the media, Banerjee says that the information is there if investors want to find it.

The SPDR S&P Emerging Markets Small Cap ETF has also seen assets soar recently, now over $1.2bn, while the WisdomTree Emerging Markets Small Cap Dividend Fund ETF has assets of $773m.

The report reveals that when emerging markets started attracting high levels of interest in the 1990s, investors poured their money into blue chip stocks. Between 1995 and 2000, the S&P Emerging Large/Mid Cap consistently outperformed its small-cap equivalent.

As emerging economies have grown though, organic demand has risen, advancing sectors such as health care, consumer staples and consumer discretionary. It is these domestically-driven sectors that have a much greater weighting within small-caps.

According to the S&P Emerging BMI index, consumer staples and discretionary together represent nearly 30% of the market in small-caps, compared with just 12% in large and mid-caps.

The turnaround has been dramatic. From December 1994 to 2000, the S&P Emerging Small Cap dropped 42.85% cumulatively; in the last ten years, it has grown 484.53%.

As of the end of September, the S&P Emerging Small Cap has posted a 16.6% ten-year compound annual growth rate, compared to 13.2% for the S&P Emerging Large Mid Cap.

While small-caps are growing, large companies have meanwhile become very large and plateaued. In a reversal of the previous relationship, the S&P Emerging Small Cap has now performed better than the Large Mid Cap in eight of the last ten years.

The report also shows small-cap outperformance appears to hold across all regions, sectors and styles. Even in typically large-cap business sectors such as telecommunications and utilities, small-caps have triumphed, up 15.7% and 20.3% respectively over the last ten years, compared to 11.7% and 16.5% in the Large Mid Cap.