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.

Small-cap ETFs have had a tendency to distribute gains in their early years but not in later years, as the redemption process is more effective at reducing gains when shares have been purchased at a wide range of prices. The long-run efficiency cannot yet be confirmed for the ETFs above, as DLS was the first one, started in 2006. DLS distributed an 0.8% short-term gain in its second year (2007), GWX distributed a 1.5% short-term gain in its first year (2007), VSS distributed a 0.7% short-term gain in its first year (2009), and EWX distributed a 1.5% short-term gain in its second year (2009).

Independent of capital gains, DLS, DGS, and PDN are likely to have higher tax costs than the other ETFs, because their indexes overweight stocks with a higher dividend yield.

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.

International Developed Markets Small Cap Index Returns
Indexes: Dow Jones Developed Markets Small Cap Total Stock Market Index; FTSE Developed Small Cap ex-North America Index; MSCI EAFE Small Cap Index; Russell Developed ex-U.S. Small Cap Index; S&P Developed Ex-U.S Small Cap Index

FTSE

 * Ishares 2009-2008

MSCI

 * Ishares 2009-2008
 * International Roulette 2007-2001
 * Denver Investments Institutional Concentrated International Small Cap Factsheet, 2000

Russell

 * Russell Periodic Chart 2009-2004

S&P

 * Goldman Sacks Fund Report 2009-2000

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
 * Hawakini, Gabriel and Keim, Donald B., "The Cross Section of Common Stock Returns:A Review of the Evidence and Some New Findings ". Wharton 1999.
 * 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
 * Quigley, Garrett, "Investing in International Small Company Stock," Institute for Fiduciary Education, July 8 2001.