WisdomTree

Equity, Small Caps

Think You Need a Manager for International Small Caps? Think Again.

by Christopher Gannatti, Associate Director of Research on June 23, 2015

With the increased availability of index-based, passive approaches for investing in equities, investors are continually analyzing where they fit in the context of the active vs. passive debate. It is fairly common to hear that in large-cap equities, which are perceived to be more efficient, there is less opportunity for active managers, so passive approaches make sense.

However, it is in small caps—especially outside the United States—where active investment philosophies are believed to have greater potential to shine. WisdomTree introduced the first international small-cap ETF in 2006, and our record calls conventional wisdom into question. Some of WisdomTree’s best performance against active and passive peers alike has been in the international small-cap arena.

Managing the Most Important Risk: Valuation

Many times, small-cap stocks can respond quickly to changing conditions, which can lead to large swings in performance. We believe that with this responsiveness comes a responsibility to understand the susceptibility to overvaluation.

To confront this risk, the WisdomTree International SmallCap Dividend Index is rebalanced annually. In essence, the process takes a detailed look at the relationship between dividend growth and price performance of developed international small-cap dividend payers. Once a year, the Index adds weight to stocks that have become less expensive and takes weight away from stocks that have become more expensive. In other words, the Index annually adjusts exposures by:

Adding Weight: Companies that have grown their dividends but whose prices may not have responded commensurately typically have the best chances of increasing in weight.

 

Subtracting Weight: Companies whose prices have performed very well but whose dividends have not grown commensurately typically have the best chances of decreasing in weight.

WisdomTree believes that taking the chips off the table at regular intervals after strong performance is critical to a strategy seeking to build a strong performance record over time.

Proof in Performance

The WisdomTree International SmallCap Dividend Fund (DLS) is built to track the returns of the WisdomTree International SmallCap Dividend Index after costs, fees and expenses. It has a long track record of almost nine years of live performance, and we look to compare it to active managers and ETFs in the Morningstar Foreign Small/Mid-Cap Value Category.

DLS versus the Morningstar Foreign Small/Mid-Cap Value Peer Group (7/1/2006 to 3/31/2015)

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DLS v. Morningstar Foreign Small-Cap Value Peer Group (fig. 2)

Beating 80% Since Inception: DLS has beaten 80% of its peer group since its inception, with a return of 5.1%. The MSCI EAFE Small Cap Index—an important benchmark for this category—beat nearly two-thirds of the peer group over the same period. Contrary to what many might initially believe—that you need active managers to outperform in small caps outside the U.S., the evidence over this period may suggest otherwise.

Important Risks Related to this Article

There are risks associated with investing, including possible loss of principal. Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty. Funds focusing their investments on certain sectors and/or smaller companies increase their vulnerability to any single economic or regulatory development. This may result in greater share price volatility. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.