Comparing Small-Cap, Emerging-Market ETFs

The category of emerging-market, small-cap stocks now has two ETFs to compare and contrast.

As the ETF industry creates more innovative products, it's creating access to segments of the market that may not have been easily accessed via index funds in the past, and this is one.

The first to list was the WisdomTree Emerging Markets Small Cap Dividend ETF ( DGS) and, in the last few days, the SPDR S&P Emerging Markets Small Cap ETF ( EWX) came along.

Below is the back test for each fund compared to the iShares Emerging Market Index ETF ( EEM).

1 Year 3 Years 5 Years 10 Years
EWX 15.37% 26.98% 33.14% 11.65%
DGS 17.11% 26.24% 36.77% 21.03%
EEM 21.65% 29.64% 35.95% 12.53%

On first glance, the nod would seem to go to DGS -- but there is one thing that muddies the waters.

The above numbers for DGS include reinvestment of dividends.

The current yield of the index underlying DGS is 5.13%. However it is very unlikely that the actual yield of the fund will be anywhere near 5.13%.

Most of the WisdomTree dividend funds yield less than the indices they track. The easiest way to think of this is if you own 100 shares of Exxon Mobil ( XOM) on ex-dividend date, but you own 200 shares on the pay date, you get only the dividend for the 100 shares.

As new assets flow into many of the WisdomTree funds, they have metaphorically owned 100 shares on ex-date but 200 shares on pay date, and have to pay the smaller dividend over the larger share quantity.

I don't think this makes WisdomTree funds bad to hold (I use several of them in my practice), but if the dividend of the fund ends up being less than the index, it becomes a much closer call between DGS and EWX.

Maybe looking under the hood can help solve this.

Both funds have similarities in country weights (EWX is 32% Taiwan, while DGS is 26% Taiwan, for example). But DGS makes several larger country bets on South Africa, Thailand, Malaysia, Korea and Israel -- all close to 10% -- while EWX makes smaller bets, except for Taiwan.

Also, EWX allocates a little bit to frontier markets like Egypt, Pakistan, Morocco and Jordan, while DGS does not.

There is some differentiation in the sector mix, but the differences are logical. EWX is heaviest in technology at 21.95% -- which makes sense, given that Taiwan is a technology-based country, and the fund is so heavy in tech. It's also heavy in financials at 19.14% and industrials at 16.54%.

DGS appears to spread the sector exposure a little more -- but actually, it looks as though instead of providing a sector breakdown, WisdomTree provides more of a subsector breakdown.

That's more useful, but would not be apples to apples with EWX.

DGS appears to be 28% industrials (transportation, capital goods and autos), 12.84% materials, 13% staples and 10% technology (hardware, semiconductors and software).

The fees are similar: 0.65 for EWX and 0.63 for DGS. The yield for EWX's index is 2.63%, and for DGS' index it is the aforementioned 5.13%.

There is no obvious better choice.

I think the nod (but it is a slight nod) goes to DGS, based on its sector make-up. If you prefer the tech exposure, EWX makes more sense -- but before jumping into that one, you should look at iShares MSCI Taiwan ( EWT) for purer emerging-market tech exposure.

While I think the frontier markets in EWX are interesting, there will be a slew of frontier-market products coming before the end of the year that would be a better way to capture that segment.

At the time of publication, Nusbaum was long EWT on behalf of clients, although positions may change at any time.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback; click here to send him an email.

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