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Small cap is beautiful says WisdomTree

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A new note from WisdomTree finds that one of the big trends in the exchange-traded fund (ETF) industry has been this year’s flow of new money into developed world equity ETFs, both unhedged and currency-hedged.

 WisdomTree estimates that nearly USD100 billion of this year’s USD271 billion in ETF industry inflows came into these funds through the end of October. The firm writes that while the vast majority of assets in developed world equity ETFs—and the vast majority of net inflows this year—have been concentrated primarily in large-cap strategies, the bigger bull market has actually occurred in the smaller-company segment of the developed world.
 
The firm finds that small-caps have outperformed compared to broad market indices comprising primarily large-caps across 2015. “What’s interesting is that the excess return produced by small caps compared to their large-cap peers is not just a 2015 phenomenon. Excess returns have held up over the last year, three years, five years and the better part of the last decade going back to the inception of the WisdomTree Indexes back in May of 2006,” the firm writes.
 
“The gains that developed world small caps have generated thus far in 2015 have not only surpassed the broader regional benchmarks, they have outperformed the major asset classes investors typically tap to construct a globally diversified portfolio: large caps and small caps in the US; MSCI EAFE Index and MSCI Emerging Markets Index; REITs, US Treasuries, investment-grade and high-yield corporate bonds; commodities and gold. Moreover, year-to-date in 2015, small caps outperformed each of the major indexes designed to measure how each smart beta factor is performing: MSCI Momentum, MSCI Quality, MSCI Value or MSCI Size.”
 
WisdomTree believes that the reason for the divergence in returns lies in part in sector concentrations, country and currency exposure. “Another reason: Small-cap stocks are less tied to the global economy and often more sensitive to inflections in local economies. The potential for higher returns compared to large caps and the diversification benefits within a globally diversified portfolio are key reasons why WisdomTree became the first ETF manager to launch small-cap ETF strategies,” the firm writes.
 
“Because most passive indices and active international managers tend to concentrate primarily on large-cap stocks, international investors may miss the potential of small-cap companies unless they make a conscious effort to include them in their portfolios.
We believe small-cap exposure can help investors complete their international allocations. Returns this year in Europe and the developed world add additional real-time evidence to support our thesis.”
 
 

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