International small cap

Since domestic large-cap stocks and international large-cap stocks have high correlation, some investors look for international small-cap mutual funds and ETFs to further diversify their portfolios. This page is intended to present a summary of international small-cap mutual funds and ETFs.

Tax Efficiency
Vanguard International Explorer Fund has been very tax inefficient at least for the past 10 years. You should strongly consider holding it in a tax-advantaged account.

Vanguard FTSE All-World ex-US Small-Cap Index Fund imposes non-expiring purchase and redemption fees on its mutual fund shares and thus discourages trading by imposing a cost on every trade. Given the volatility of small cap stocks, there are many opportunities for tax loss harvesting, but the redemption cost significantly reduces the benefit.

The purchase and  redemption fees can be avoided by using the ETF class; there are still brokerage fees and trading costs, but the fees can be less than purchase and redemption fees. This Calculate and compare costs for Vanguard ETFs and mutual funds calculator can help quantify the fund vs. ETF decision.

The ETFs listed above have not been around for a long time. As such, there is little information on their tax efficiency, and what there is may not be reliable in the long run. However, the WisdomTree ETFs, because they choose stocks which pay high dividends, are likely to be tax-inefficient even if they do not realize gains, and GWX had an 0.87% tax cost in its first year because it distributed a large capital gain. (This may be less of a concern in the future; many ETFs distributed capital gains in their early years but not in later years even in bull markets, and any ETF which was around in 2008 has a large loss to offset gains for several years in the future.)

Volume
Many of the ETFs above are thinly traded. You should expect larger-than-average bid/ask spreads.

Underlying Securities
The products above have quite different sets and weights of underlying securities. One product might include stocks from one country, whereas another product might completely lack them. You are strongly advised to read the prospectus of each product and, if necessary, do additional research before investing in any of the products above.

Resources

 * Altruist FA: Foreign Developed Markets Small Cap Funds
 * Altruist FA: Emerging Markets Small Cap Funds

Academic Papers

 * Huang, Wei, Eun, Cheol S. and Lai, Sandy, "International Diversification with Large- and Small-Cap Stocks" . Journal of Financial and Quantitative Analysis (JFQA), Forthcoming Available at SSRN: http://ssrn.com/abstract=932961
 * Huang, Wei, "Financial Integration and the Price of World Covariance Risk: Large vs. Small-Cap Stocks " . Journal of International Money and Finance, Forthcoming Available at SSRN: http://ssrn.com/abstract=898067
 * Nicodano, Giovanna and Guidolin, Massimo, "Small Caps in International Equity Portfolios: The Effects of Variance Risk" (December 2005). AFA 2006 Boston Meetings Paper Available at SSRN: http://ssrn.com/abstract=686142
 * Petrella, Giovanni, "Are Euro Area Small Cap Stocks an Asset Class? Evidence from Mean-Variance Spanning Tests" . European Financial Management, Vol. 11, No. 2, pp. 229-253, March 2005 Available at SSRN: http://ssrn.com/abstract=688650