Many investors limit themselves to large cap companies when investing in foreign stocks. This is because large multinational companies are usually well-known and information about them are easier to access. In addition large-cap stocks are well followed by the investment community and are usually listed in major exchanges. Since putting one’s money in companies of faraway countries involves high risk, sticking with large companies seem to be the wise choice. However in order to gain higher returns from investing in international stocks, it is wiser to go with small cap stocks as opposed to sticking with only large caps.

Unlike large cap companies, small companies are most likely to benefit from the growth in domestic economies and small firms generally tend to depend on local markets for their earnings.

A recent article in the Journal discussed the advantages of investing in foreign small caps. From the article:

Small adventures

Such an unorthodox approach can make sense for several reasons.

• First, small-caps provide true portfolio diversification. Small companies, no matter their location, typically operate exclusively in their home market. Consequently, these stocks offer a pure play on an economy—an Italian supermarket chain relies on Italian shoppers, for instance.

By contrast, large companies tend to compete with rivals across borders. South Korean phone giant Samsung, for example, battles Apple for customers world-wide. In a portfolio, such similar holdings can overlap and limit the benefits of diversification.

• Second, international small-cap funds have outperformed larger-cap peers, gaining 7.85% on average in the 10 years through June 2015, for example, versus a 5.22% annualized return for larger-cap international funds, according to S&P Dow Jones Indices.

• Third, international small-cap is among the few stock-fund categories where fund managers have posed a stronger challenge to ETFs and other indexed offerings. That is in part because foreign small-caps aren’t as well covered by analysts as their larger cousins, giving astute stock pickers a fighting chance to outperform.

About 44% of international small-cap fund managers beat their benchmark index over the decade through June 2015, compared with 18% of actively run larger-cap international funds, S&P Dow Jones Indices reports.

Source: The Case for Buying Small-Cap Foreign Stocks, WSJ, Feb 7, 2016

Sometimes simply going with large caps won’t give exposure to the country’s growth. For instance, many of the FTSE 100 in the UK derive most of their revenue from overseas instead of the domestic market. So investing in these firms or the FTSE 100 index via an ETF does not give exposure to small and medium British firms which tend to follow the domestic economy. So companies in the FTSE 250 index are better ways to invest in the UK.

There are also many disadvantages of investing in foreign small caps. Some the cons include:

• Information on many small cap overseas firms may be difficult to find online. Though they may have a website the information presented may not be thorough and detailed.
• Small caps are inherently more risky than large caps. During economic downturn they will fall harder due to their smaller size.
• Unlike large caps small caps may not pay a dividend or have a tiny payout as they are more focused on growth than rewarding shareholders.

Despite the problems with international small caps, they have many advantages and a small allocation to these stocks in a diversified portfolio can amplify returns in the long-return.

Four ETFs that give access to foreign small cap companies are listed below for consideration:

Vanguard FTSE All-World ex-US Small-Cap ETF (VSS)
SPDR S&P International Small Cap ETF (GWX)
iShares MSCI EAFE Small-Cap ETF (SCZ)
WisdomTree International Small Cap Dividend ETF (DLS)

Disclosure: No Positions

Volatility continues to plague global equity markets since the beginning of the year. Like clockwork, stocks are up one day only to fall the next day. One or two or even a few up days in a row seem to be the start of prolonged bull market. But alas, those dreams seem to be disappear quickly when starts decline again on a day like today due to the same old reasons like economic growth fears, oil prices, etc. So in a market like some investors may be tempted to dump stocks and then buy them at a later date when they are cheaper. Basically such investors are trying to time the market – which is next to impossible for most investors.

Here is an excerpt from an article in The Financial Post discussing the volatility of the TSX Index:

In these jumpy markets, triple-digit swings are the daily norm. Even though there aren’t many places to turn a profit these days, the pressure to generate consistently positive returns is as high as it has ever been, which has made money managers nervous and impatient.

“Investors want all these short-term gains, and that’s what’s causing all this volatility,” Brian Belski, chief investment strategist at BMO Capital Markets Corp., said in a recent telephone interview. “People are too focused on today and tomorrow, not six months from now, let alone a year from now. Nobody thinks out one year from now because they have to perform.”

This shift in mentality could be pushing shares much higher on good days and lower on bad ones.

If more people are looking to make a quick buck in stocks, losing trades will be swiftly dumped before those losses mount. And if holding periods shorten, equities will be afforded even less time to rise before an impatient trader clicks the sell key.

Source: Is the recent TSX rally the calm before the storm?, The Financial Post, Feb 23, 2016

I have written many times before about the dangers of market on this site before. I came across an informative article by Seth Masters of Alliance Bernstein on this subject. From that piece:

If you’re a long-term investor, you should be confident in two key beliefs before you act on your impulse to get out of today’s rocky stock market.

#1 You’ll Know When to Get Back In

Stock market sell-offs often seem to arrive out of nowhere. So do recoveries. Even if you time the sell decision perfectly, if you’re a long-term investor, you’ll need to buy back into the market eventually.

Since the market recovery began nearly seven years ago, the S&P 500 has risen about 178%. But the market’s upward climb has been punctuated by a series of pullbacks, as the Display below shows. There have been 17 different dips in which the S&P retreated by 5% or more. On average, it has taken about 31 trading days for the market to find a bottom—and about 30 trading days to reclaim the prior peak.

But recoveries aren’t marked by an “all-clear sign.” Indeed, the market often rallies despite continued investor concerns. Investors who sell during periods of market stress often feel the pain of loss twice: first, when they lock in their losses, and second, when they miss out on the eventual recovery.

Source: Think Before You Sell, Seth Masters, Alliance Bernstein, Feb 10, 2016

The following long-term chart shows the ups and downs of the FTSE 100 Index since 1996. Since that year, the index has grown by about 58% based on only price appreciation, If dividends re-investments are included it has more than doubled during the time period. However only those investors who have held during the rough times would have seen their investments double. An investor following the market timing strategy would have had to sold and bought back at the right times during the period time. Like Seth points out, while selling stocks may be easier, buying at the low point is not easy as there is no announcement made that says like “This is the bottom folks. Buy Stocks. Now !”.

Click to enlarge

Source: Google Finance

In summary, it is always wise to ignore short-term market movements and instead focus on the long-term return of investments. Though oil and China are getting investors’ attention these days, five years from now they would probably be put on the back burner and some other factors may determine the markets’ movements.

The number of publicly-listed companies are much higher in foreign markets than in the US markets. So foreign stock markets provide a fertile hunting ground for stock pickers. US investors restricting them to domestic companies lose out on many of these potential opportunities.

The chart below the total number of listed companies in  the world at the end of 2015:

Click to enlarge

Source: 2015 Market Highlights, World Federation of Exchanges

Asia-Pacific has the highest number of listed firms followed by Europe, Middle East and Africa (EMEA).

In the US, NYSE has about 2600 firms listed including some foreign issuers. As of Dec 31, 2015, 513 foreign companies are listed on the NYSE. NASDAQ has about 3300 firms (including some foreign companies) listed.In addition, hundreds of foreign stocks can be accessed via the OTC markets.

However many foreign companies are not listed on the US exchanges or traded on the OTC markets. By going abroad one can access many of these foreign firms.

In IPO listings also, foreign markets especially those in the Asia-Pacific have more listings recently than other regions as shown in the chart below:

Click to enlarge

Source: 2015 Market Highlights, World Federation of Exchanges

Key Takeaway:

Instead of purely focusing on US stocks, investors can explore their horizon and expand their investment universe by venturing into far away countries.