Helped by the Federal Reserve’s September interest rate cut of 50 basis points, domestic small-cap stocks and the related exchange traded funds caught a bid. For example, the Russell 2000 Index is higher by 1.47% over the past month.
That’s noteworthy. However, investors may want to be careful about home country bias. Some market observers believe opportunity abounds with European small-caps. Should that outlook be validated, ETFs such as the WisdomTree Europe SmallCap Dividend Fund (DFE ) and the WisdomTree Europe Hedged SmallCap Equity Fund (EUSC ) could be worth examining.
Specific to EUSC, that ETF may not be getting the credit it deserves. It’s traded modestly higher in recent weeks, but the European Central Bank (ECB) has cut interest rates several times with more cuts expected, indicating more euro weakness could be in store. That could highlight the advantages of EUSC currency hedging strategy.
European Small-Caps
European small-caps are more domestically focused, making those stocks higher beta proxies on regional economies than large-cap peers.
“It is important to bear in mind that European small caps area higher beta equity vehicle on the region’s economy compared to large caps, with exposure to industrials and materials and a lower exposure to consumer staples and healthcare versus large caps,” noted Mathieu Bernard of BNP Paribas. “So, if white goods were to contribute to an economic recovery or expansion, it would probably support the performance of European small caps.”
DFE and EUSC answer that sector call. The former allocates more than 31% of its weight to industrial stocks. That sector and materials combine for over 35% of the EUSC roster. Beyond sector exposures, the WidsdomTree ETFs may discover other tailwinds. These include earnings per share growth that exceeds that of European large-caps.
Quality Traits
Additionally, and this might surprise U.S. investors, European small-caps have quality traits.
“Another catalyst favourable to European small caps has to do with the overall quality of the balance sheets,” added Bernard. “The percentage of significantly leveraged companies tends to be lower in the European small cap universe than that of large caps. This should give room for higher capital returns to shareholders, dividend growth, and/or share buybacks.”
Shareholder rewards and strong balance sheets can act as reducers of volatility. This potentially makes European small-caps more appealing to U.S. investors.
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