iShares Debuts Small Cap Emerging Markets ETF (EEMS)

by on August 18, 2011 | ETFs Mentioned:

iShares, the market leader in the U.S. ETF industry, rolled out a complement to its ultra-popular MSCI Emerging Markets Index Fund (EEM) on Thursday. The recently launched MSCI Emerging Markets Small Cap Index Fund (EEMS) will offer exposure to small cap companies in developing economies by seeking to replicate an index comprised of stocks that represent approximately the bottom 14% of market cap. The underlying index consists of approximately 675 stocks from 21 different emerging market economies. The largest country allocations go to Taiwan (20%) and South Korea (17%), with Chinese companies listed in Hong Kong, India, South Africa, Brazil, Malaysia, and Indonesia also receiving significant weightings.

Small Cap EM ETFs

EEMS isn’t the first ETF to focus on small cap stocks in emerging markets. State Street launched its S&P Emerging Markets Small Cap ETF (EWX) more than three years ago, and WisdomTree also offers an Emerging Markets SmallCap Fund (DGS debuted in late 2007). Those funds have become increasingly popular in recent years–aggregate assets total nearly $2 billion–as investors have sought to round out the exposure offered by large cap heavy emerging markets ETFs.

Many of the “first generation” of international equity funds, including EEM and VWO, are dominated by large cap stocks. While that approach delivers exposure to significant portions of the total market cap in a country or region, it also has some potential drawbacks. Large cap-heavy indexes tend to include significant exposure to the energy and financial sectors, since banks and oil companies are often among the biggest companies in any market. The consumer and technology sectors often receive relatively small allocations, potentially overlooking segments of the market that may maintain promising long-term return potential. As such, there is obvious appeal to utilizing small cap stocks to achieve emerging markets exposure that is more rounded in terms of sector exposure.

Sector EEM EEMS
Financials 24.1% 16.6%
Energy 14.7% 2.1%
Materials 14.4% 14.9%
Technology 12.1% 15.1%
Consumer Disc. 7.8% 17.1%
Industrials 7.6% 16.9%
Telecom 7.3% 0.8%
Consumer Staples 6.7% 8.7%
Utilities 3.4% 2.9%
Health Care 1.1% 4.9%
From iShares.com. EEMS data reflects underlying index

Indeed, a quick look at the breakdown in sector allocations between EEM and EEMS highlights the potential for the new iShares product to complement the existing emerging market exposure many investors already maintain through large cap heavy funds. EEMS makes its largest allocations to consumer discretionary companies, a sector that accounts for only about 8% of EEM’s portfolio. And the small cap product has little in the way of energy exposure, going light on a sector that accounts for about 15% of EEM.

Greater Pure Play Potential?

Some investors also believe small caps offer a better “pure play” on the emerging markets where they are headquartered. Whereas mega cap stocks are often multi-national firms that generate revenue around the world, small caps are more likely to be impacted substantially by changes in local consumption patterns. There are often substantial return differentials between large cap and small cap ETFs that focus on the same markets [sort emerging markets ETFs by returns].

In addition to the broad-based small cap emerging markets ETFs, there are also a number of products targeting small cap stocks in specific regions, including China, India, Brazil, and Mexico.

EEMS will charge an expense ratio of 0.69%, in line with the large cap EEM. That’s roughly in line with competing products; EWX charges 0.65% while DGS costs 0.63% annually [sort Emerging Markets ETFs by expenses].

New Target Retirement Date ETFs Too

Along with EEMS, iShares also rolled out a pair of long-term target retirement date ETFs. The S&P Target Date 2045 Index Fund (TZW) and S&P Target Date 2050 Index Fund (TZY) are the most recent additions to a suite of products designed to offer one-stop exposure to strategies appropriate for investors with specific target retirement dates. iShares already offered target retirement date funds with horizons ranging from 2010 (TZD) to 2040 (TZV).

iShares’ target retirement date ETFs are ETFs-of-ETFs designed to transition exposure to key asset classes as the specified retirement date approaches. Longer-term funds such as the recently-launched TZW and TZY will have hefty allocations towards risky asset classes such as international equities, while funds like TZD are heavier in fixed income. That allocation shifts over time, moving more assets into securities with lower volatility as the target retirement date approaches and the appetite for risk presumably declines.

Both TZW and TZY will charge an expense ratio of 0.32%. With the launch of these products, there are now 15 ETFs in the Target Retirement Date ETFdb Category.

Disclosure: No positions at time of writing.