Analysts are estimating that, by 2015, nearly one-third of Financial Times' Global 500, the international version of the S&P 500, will be from emerging market nations. These companies will become global household names just as big as Coca-Cola Company (NYSE:KO). Research think tank McKinsey and Company estimates that compounded annual growth in consumer goods in developed markets from 2005-2010 will be average around 4%, compared to the average 10% in emerging nations. Some will have even more such as Indonesia and its forecasted 16%.
Total planet-wide financial assets peaked in 2006, with $167 trillion, of which $24 of that was in emerging markets. However, emerging markets only accounted for 23% of global GDP in 2006. With the continued influx of capital, emerging markets still seem undervalued over the long term, on a global basis. (For more, check out Go International With Foreign Index Funds)
IN PICTURES: 20 Tools For Building Up Your Portfolio
Small capitalization stocks represent the entrepreneurial economy. After all, even the largest software company started off in a garage or basement. As a sector, stocks with small market caps have really shined. In all, these companies have produced on average returns of about 12% a year since 1926, compared with a 10% return for big stocks, according to Morningstar. This is ever-more evident as emerging nations have restrictions on ownership and an abundance of capital has taken hold, allowing more and more people to start successful businesses. The big stocks of tomorrow will come from the small stocks of today.
Getting Into the Emerging Markets
Emerging market investing at best is like walking through a battlefield blindfolded. Add the already volatile nature of small caps to the mix and you have a much higher risk profile. Investors can choose to tilt their portfolios towards individual companies such as China's Kongzhong (Nasdaq:KONG), but this lacks the benefit of diversification across several sectors and different emerging markets. Luckily, thanks to the ever-growing exchange-traded product boom, investors have a few choices for exposure to the emerging market small cap sector.
WisdomTree's Emerging Markets Small Cap Dividend Fund (NYSE:DGS), true to the issuers mission statement, follows an index of companies that are weighted based on annual cash dividends paid. Surprisingly enough, of the ETFs 377 holdings, only 15% are in financial stocks. This is usually not the case for high yielding exchange traded funds. Top sector allocation goes to industrials (22%) and information technology (20%). The fund is Taiwan-heavy, at nearly 32% of assets, but gives plenty of exposure to other nations such as South Africa, Turkey, Israel and Chile. China and Brazil are the only two BRIC nations in the top ten in terms of country weightings. A better choice for gaining BRIC small cap exposure would be Claymore's China Small Cap (NYSE:HAO) and Market Vectors Brazil Small-Cap ETF (NYSE:BRF). The fund yields 3.71%. (For more, check out Build A Portfolio With Style Investing.)
For a more traditional market cap size weighted index, the SPDR S&P Emerging Markets Small Cap (NYSE:EWX) provides access to 279 different small caps. The fund, again, is Taiwan-heavy, but gives more BRIC exposure with China, Brazil and India rounding out the top five country weightings. Distribution yield is pretty much nonexistent at 0.72%, and annual expenses run comparable with the WisdomTree fund at 0.65%. The fund would make a good choice for investors not wanting to separate their BRIC exposure from the rest of their emerging market pie. (For related reading, see Forging Frontier Markets.)
The Bottom Line
In finding the global leaders of tomorrow, sometimes we need to look small. Emerging markets offer some of the best long term returns around, and emerging market small caps represent a new frontier for the individual investor. The proceeding ETF's offer an easy and diversified way to play the growth in those nations.
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!