International Small-Cap ETFs Make Move

By Michael Johnston, founder of ETF Database

The tremendous increase in the number of exchange-traded funds launched in recent years has seemingly brought cheap, efficient access to nearly every corner of the globe within reach of U.S. investors.

There are now funds devoted to Vietnam, Turkey, Israel, Colombia, among countless other countries. But while the breadth of international options has expanded significantly, the exposure offered by such funds is fairly limited, as most international exchange-traded products are dominated by mega-cap equities.

Blue-chip indexes may technically offer exposure to foreign markets, but their correlation with the local economy is often far from perfect. Spain is perhaps the best example of this phenomenon. The iShares MSCI Spain Index Fund>(EWP) invests exclusively in Spanish companies. A look under the hood, however, reveals that nearly 45% of EWP is allocated to Banco Santander and Telefonica, two companies that are listed on Spanish stock exchanges but derive a significant portion of revenues and profits from foreign markets.

While the Spanish economy struggled with skyrocketing unemployment and a deteriorating fiscal environment, EWP actually gained 33% in 2009. This gain was largely attributable to big growth in the operations of Santander and Telefonica in Brazil.

International investing used to be binary process: Your portfolio either had exposure to a country or it didn't. But ongoing innovation in the ETF industry has significantly increased options. Small-cap domestic ETFs have long been popular with investors, but opportunities to access smaller companies listed in foreign markets have historically been limited. That is beginning to change, however, as investors focus more on the international component of portfolios and begin seeking out alternatives to foreign equivalents of the Dow Jones Industrial Average.