Emerging markets have come a long way in just 15 years, gaining traction in the pension space as plan sponsors look to rebalance their equity exposure in line with the shifting global economy.
One factor that makes emerging markets so interesting is the growth of their consumer base. Markets like Brazil, India and China have built a compelling story of a growing middle class and burgeoning potential for consumer consumption in the future (a story which has ended badly in developed market countries).
The problem is that tapping into consumer growth is tough if you stick to large cap indexes. Many consumer-focused stocks don’t make it into emerging market indexes, which are heavily weighted in large cap equities and are concentrated in the financial and energy sectors.
It makes it harder to get exposure to that consumer growth sweet spot.
Which is one reason why small cap emerging market indexes have become popular in the last year or so—especially as emerging markets get more expensive. Small cap stocks tend to offer exposure to consumer and technology sectors—overlooked segments of the market that could offer promising long-term returns.
A recent article on Business Insider breaks down the difference in weightings between the MSCI Emerging Markets Index Fund (EEM) and the SMCI Emerging Markets Small Cap Index Fund (EEMS). Consumer discretionary is notably higher on the small cap side, with the EEM weighted at 7.8% and the EEMS significantly higher at 17.1%.
Both State Street and BlackRock (among other firms) offer emerging market small cap ETFs. For plan sponsors looking to explore emerging markets for the long-term, a small cap index could be an interesting option. But there are risks — small caps tend to be under researched and in emerging markets where data quality can vary, you need to tread very carefully. Still, it’s worth noting which index more closely matches the growth story being told in emerging markets — these days, small caps might offer a closer match.