2023-11-08 17:42:07 ET
Summary
- The SPDR S&P Emerging Markets Small Cap ETF (EWX) provides diversified exposure to small-cap companies in developing economies.
- EWX has historically outperformed broad EM benchmarks and has gained 11% in 2023.
- The fund's sector and country allocations have contributed to its strong performance, with a focus on technology and underweighting in financials and Chinese stocks.
The SPDR S&P Emerging Markets Small Cap ETF ( EWX ) invests in companies from developing economies with a market cap under $2 billion. The attraction here is the diversified exposure to a group of stocks that may benefit from stronger potential long-term economic growth amid several secular tailwinds.
While emerging markets are recognized as being higher risk, and small-caps are typically even more volatile than their large-cap counterparts, EWX has impressively outperformed broad EM benchmarks historically. A large part of that spread reflects the fund's sector and country allocations that have simply been well-positioned in recent years.
Indeed, the EWX has gained a solid 11% thus far in 2023 despite ongoing macro headwinds and is well ahead of more high-profile EM ETFs like the iShares MSCI Emerging Markets ETF ( EEM ) or the SPDR Portfolio Emerging Markets ETF ( SPEM ) within the same fund family.
With a bullish view on equities and expectation of some favorable shifts to the macro environment, we expect EWX to continue delivering positive returns through 2024.
What is the EWX ETF?
EWX is intended to track the "S&P Emerging Markets Under USD2 Billion Index". Technically, the companies eligible for inclusion must have a market value between $100 million and $2 billion within a list of countries classified as emerging markets under the S&P Global criteria.
Constituents of the underlying index and ETF are held based on a float-adjusted market capitalization weighting methodology. Finally, there is an annual index reconstitution where the holdings are ultimately rebalanced.
What stands out when looking at the current portfolio, EWX is an extensive fund with nearly 3,500 stocks with an average market cap of $1.1 billion. The largest current equity holding is Taiwan-based "Compeq Manufacturing Co Ltd", a manufacturer of circuit boards, alongside South African retailer Mr Price Group Ltd ( OTCPK:MRPLY ), both with a 0.23% weighting.
Keep in mind that the individual companies here have less of a direct impact on the overall performance of the fund compared to the sector and country allocations along with style tilts.
The metrics we're looking at, suggest an average current forward P/E for the fund at 12.5x trading at 1.5x book value on average. The fund sponsor also notes that the average company is expected to achieve an EPS growth of around 19% over the next 3-5 years based on consensus estimates. In this case, the fund can be described as having a small-cap blend, balanced between growth and value stocks.
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EWX Performance
We mentioned EWX's historical outperformance compared to EEM as a key emerging markets benchmark along with SPEM as the large and small-cap EM ETF option from the SPDR fund family. EWX has returned a cumulative 52% total return since its fund inception date in May 2008, compared to a 27% return from SPEM and just a 6% gain in EEM.
The context here considers that the last decade has been extremely volatile and otherwise disappointing for the EM market segment. Exiting the great financial crisis, weakness in commodities and a stronger dollar in the mid-2010s contributed to lagging returns for the group.
From the chart below, it becomes more evident that the momentum accelerated during the pandemic alongside the global trend of strong equity returns over the period. EWX has opened its performance spread, particularly since 2021.
The explanation here comes down to the fund's holding profile. EWX has a larger relative tilt in the technology sector representing 19% of the fund compared to 17%, which has been one segment of the market that has continued to perform well.
Furthermore, we can also highlight that EWX is relatively underweight in financials with a 9% sector exposure compared to levels above 22% in both SPEM and EEM. Global banks have been under pressure more recently amid the trend of rising interest rates and tighter financial conditions.
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The chart below tracking the performance of the iShares Global Financials ETF ( IXG ) with a 3% total return year to date, against a 38% return in the iShares Global Tech ETF ( IXN ) helps frame the impact of the sector sizing differences in EWX versus SPEM and EEM.
The reason financials have a lower representation within EM small caps is that there is typically a concentration of large banks and state-controlled institutions in emerging markets. Naturally, these types of names would not be included in the small-cap fund which has worked out well in recent years.
The other dynamic at play is EWX's country positioning. In this case, the small-cap profile has systematically underweighted Chinese stocks at 22% of the fund compared to 31% in SPEM for example. Again, this divergence reflects the composition of each country's equity markets.
source: State Street
This is important as Chinese stocks have underperformed in recent years, marred by a regulatory crackdown in the country and disappointing economic growth emerging out of the pandemic. The combination of these factors has worked to EWX's advantage in recent years compared to most other EM funds.
What's Next for EWX?
In the context of the current macro environment, we believe the combination of declining inflation expectations and room for interest rates to stabilize lower globally should provide a catalyst for emerging markets to gain momentum.
While we don't expect EWX to necessarily outperform its large-cap counterparts indefinitely, and there is even room for China to rebound, we still believe the fund should participate in the upside. Expanding EM valuation multiples and even stronger investor sentiment can be positive for the region. We also believe a pullback in the U.S. Dollar should provide a boost to region stocks.
In terms of risks, a scenario where economic conditions deteriorate defined by a global recession or financial system crisis would open the door for a deeper selloff in EM stocks. Similarly, sharply higher interest rates, potentially driven by some re-acceleration of inflationary pressures, would undermine any bullish thesis.
Ultimately, with a decisively more optimistic view, we see room for the fund to reclaim its all-time high above $60.00 over the next year.
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Final Thoughts
EWX is a high-quality ETF that offers exposure to an often overlooked, but important segment of the market. We like emerging markets small-cap as the strategy can work as a compelling portfolio diversifier for most investors. Going through the list of underlying stocks, the combination of international names that are likely not widely held means it can complement a broad market strategy and even other EM funds.
Keep in mind that EWX features a 0.65% expense ratio while the current yield is listed at 2.5%, distributed through a quarterly dividend.
For further details see:
EWX: Outperforming EM Small-Cap ETF Makes A Great Portfolio Diversifier