Emerging Markets Small Cap Value Performance: Pretty Good.

I regularly shared with readers of Investment Moats the evidence of the size, value and quality/high profitability premium and why focusing on increasing our portfolio exposure to these risks may be rewarded in the long term.

We observe that our portfolios were hurt more than benefited from increase exposure to smaller and cheaper companies.

Underneath the systematic small + value strategy, the systematic active index would look at the universe of stocks to focus on the smaller stocks. From there, they will rank the companies from the cheapest to the most expensive using some standard value metrics such as price-to-earnings, price-to-book, price-to-cash flow or a composite of all of them.

They would either pick the Top X ranked and readjust their portfolios to hold this periodically. The period can be every quarter or half-yearly.

Investing in a fund that tracks such a systematic active index allows you to match your value + small investment philosophy. That is, assuming you buy into that.

There should be a fundamental basis to why investing in smaller, cheaper, more quality or higher momentum companies will do better in the long run. You should fear your investments or strategy the more well it runs if you cannot discern the underlying basis of your fund’s performance.

More so, these premiums or excess performance over taking market risk should be:

Pervasive: Cannot be only show up if you invest in US small caps for example, they should show up in other areas.
Persistent: The premiums should not just show up for a short period and disappears after that. For example, people have been trying to buy cheaper stuff and selling when they are dear for centuries. Why do they keep doing it? Likely fundamental reasons and also because it worked.

The place to proof this sometimes is to look at spaces that are less popular.

I stumbled upon the SPDR MSCI Emerging Markets Small Cap UCITS ETF (Ticker: EMSD) when I was looking to see if I can move away from a market-based approach for my emerging markets allocation. Currently, I invest in the iShares Core MSCI EM IMI UCITS ETF USD ETF (EIMI). I like this ETF due to its IMI nature. IMI covers not just the large and mid-caps but also the small-caps in the space.

Both ETFs are listed on the London Stock Exchange and you can invest in them cheaply through a broker like Interactive Brokers.

Naturally, I would check out the performance to have a view of how well they do recently. Emerging markets have not performed well for the past 10-14 years. I think if we want to observe an areas that is “less tainted by US-lead performance”, this is an ideal area to look at.

Growth of $1 from 2016 to Today

A growth of wealth chart like the one below shows the idea that if you invest $1, or $100k, or $1 million at the start, how much you will end up with at the end.

This chart shows the growth of $1 for the MSCI Emerging Market Index (cyan) against the EM Value (purple, primarily large cap), against the EM Small Cap (red/brown) and the EM Small Cap Value (green).

Here are the annualized and cumulative performance over this period with the cumulative in brackets:

EM Index: 6.3% p.a. (68%)
EM Value: 6.1% p.a. (68%)
EM Small Cap: 8.3% p.a. (98%)
EM Small Cap Value: 9.2% p.a. (114%)

I was shocked by how practically there was no difference between EM and value during this period. I was even more shock of the difference between small cap and large cap.

The end does not tell the full story. If you trace through the experience, you would have not ever invest in the small-cap or small cap value.

Take a look from Jan 2016 to Jan 2021.

You will notice that the blue and purple lines, represent the market cap-weighted index and the value index have lead through this period.

That is almost five years.

If you have invested for five years, and see the market-cap index with the Alibaba, Meituan and Tencent lead you for so long, would you have throw in the towel and switch over to a large-cap market weighted index?

I think what is also interesting is to see the light green line, representing the small-cap value trying to keep close to the market-cap weighted large cap all this while.

Then in October 2021 everything flipped.

For these 2.5 years, the small cap reigns supreme.

Growth of $1 from 1999 to Today

How are things in the past 24 years?

That would include a period of transition from the BRICs (Brazil, Russia, India and China), primarily very banking and industrial focus to a period where China forms a larger percentage of Emerging Markets and where Information Technology firm like Alibaba, Tencent reign supreme.

Here is how the chart looks like:

Here are the annualized and cumulative performance over this period with the cumulative in brackets:

EM Index: 7.7% p.a. (562%)
EM Value: 7.8% p.a. (578%)
EM Small Cap: 8.8% p.a. (766%)
EM Small Cap Value: 10.8% p.a. (1283%)

I think most would notice one thing clearly: That green line.

That small cap + value is rather persistent in a period where people say value is dead. The fact that it has worked in a short and long period must amount to something.

The unfortunate thing is that there isn’t a Systematic Active ETF that does emerging market small-cap value. Even Dimensional, who is tilted towards value usually, kept their fund offering in this region on Emerging market large cap.

There was practically not much noticeable difference between Large Cap blend and Large Cap Value.

I think the performance of the emerging market small cap is also interesting. Notice that all this while, that brown/red line have either underperform or just keep to the index, never exceeding it.

Until Jan 2023.

That is when they start exceeding it.

How would you feel if you invest for 23 years and falling short?

Yet on hindsight, the returns a year later would show you that you would have done better had you not thrown in the towel and sell one year before.

This is why I think investing is hard.

The Emerging Small Caps is Not Too Different In Volatility Compare to the Large Caps

Here is the annualized standard deviation from (1999 to 2024):

EM Index: 21.1%
EM Value: 21.1%
EM Small Cap: 21.6%
EM Small Cap Value: 21.8%

All the indexes’ standard deviation is not too different. It is just that their standard deviation is much higher than the standard deviation of a portfolio of developed market equities.

That is quite weird if investing in smaller and cheaper companies are supposed to be riskier and we should be rewarded with higher return.

I think during this period, each index portfolio is not more riskier than the other by much, but then again, I can’t explain the performance of EM Small Cap Value here.

Rolling Returns – Investing $1 million at Any Point in the Last 24 years for a Period of Five Years.

Some may be curious if you have all your net wealth and you decide to put in any point in the past 24 years, how would your returns be like if you stay invested for five years.

This is why we look at the following annualized rolling return chart:

Any point on this chart is an annualized compounded return over five years.

We notice the volatility in the returns. There are periods where your $1 million grows 44.9% p.a. for the past five years and just as likely grows at -5.2% p.a. for the past five years.

This chart kind of tell us how hard it is to trust what we see in hindsight because each is not distinctly better.

Perhaps we can see a distinct ranking:

EM Small Cap Value
EM Small Cap
EM Value
EM Index

The only time where the large cap blend market-weighted index did better were those 5-year periods from Jan 14 to Jan 17.

That is a pretty long period.

Rolling Returns – Same Period but Investing for 10 Years instead of 5 Years

I wanted to take a look at how the returns are like if we invest for a longer period of 10 years instead of 5 years. We are using the same period from 1999 onwards.

Here are the results:

The fist thing I notice is how shit the results for Emerging Markets Value is. It was that bad that I had to recheck my data calculations to see if there is a mistake.

There is a premium for value if we are above the 50th percentile but below that, Emerging Markets actually did worse.

The second thing you may notice is that after investing for ten years, all four will have a poor ten-year period. Investing in equities requires a longer time horizon, or when you need the money.

There is this risk of doing badly for a long period, and therefore it makes it possible for you to get good returns.

Beyond that, I notice something that I notice when looking at US or World Small Cap: Their very pessimistic compounded returns look much better than the large caps.

I wonder this can be chalked to higher risks taken and therefore higher returns harvested resulting in better performance.

I am sure living through that portfolio experience may be very different than looking at returns in hindsight.

How Different Are the Portfolios?

You can easily Google the Factsheets for these value, small tiltes by trying to search for “MSCI Emerging Markets Value” for example.

I have help to tabulate the top ten holdings, the regional and sectoral breakdown below:

Emerging markets have changed a fair bit. Even I was surprised by the dominance of semi-conductor-related allocation nowadays.

And that is something to remember.

If I invest in such a portfolio, I am trying to get exposure to the equities of a region but I have no control over which area will do well or to speculate in them. You can use an individual country ETF if you have a view about the markets and can express accordingly.

But let us sit and digest that we transit from the BRICS to China dominant and now to a better mix of Taiwan, India, Korea and China.

The EM Value has as heavy of a weightage as the EM Blend index, and the similar stocks, just the allocation is different. The regional allocation will maybe tell you the difference in performance. The large cap is more China heavy while the small cap is India heavy.

The sector allocation is more balance for the small cap and small cap value.

I bet that many won’t recognize the top ten holdings in small cap and small cap value.

I don’t recognize them personally.

Marketing this best performer to our clients would be a nightmare. “So what fund are you recommending me hold currently?”

Me: “A bunch of very small stocks, each not making up even one per cent of the portfolio. I tried looking up what they do but that is it. Honestly, I don’t know why they are doing so well. I know they are cheap, though.”

“So you don’t know any of these companies, and half a year later, this fund will buy into another bunch of no-name companies? How do I know if these companies will remain profitable????”

“I don’t. I only know they just keep buying cheap companies. And this is the historical result. Seems to beat the shit out of these companies you are more familiar with though.”

Actually, the smaller companies aren’t too much cheaper as a cohort:

I guess when we lit value and size together, we got a very potent chemical reaction.

Emerging Markets Small Cap Value Versus Value-weighted

Most readers can ignore this section. I became curious about how different the performance would be if we changed how the portfolio constituted value.

A value-weighted method overweight the portfolio based on a composite value screen instead of a more simple one.

This will result in a different portfolio flavor.

If so, how would the performance be:

Turns out small cap value did better in all time frames. The Small Cap Value Weighted actually did worse than general small caps (not included in this table).

Further Thoughts about the Historical EM Small Cap Returns and Why Most Value Fund Managers Cannot Beat this Return.

One of the toughest thing for some investors is to invest in something that they are unfamiliar with and purely based on trusting the data and the basis.

I used to manage my portfolio with individual stocks and I would explain to others that you need to know what you are investing in.

And yet if we look across this 24 years… The Emerging markets small cap and small cap value were able to provide this kind of returns, despite us not knowing:

The companies that will be in your portfolio.
How profitable or unprofitable these companies are and how long they will remain in that state.

This is a feeling that many of us will acknowledge if we reflect further and feel uneasy about.

We can say the same for EM Value as well.

Yet whether the returns are good or not, weirdly if you invest long enough, there IS some returns at the end.

So what drive those returns?

A general earnings per share growth in the segment that you invest in. If valuation remains at it is, rising earnings per share would mean the price have to go up.
These businesses have more uncertainty than more establish businesses. They are high risk. And therefore require a greater return to compensate for the risk we are taking. Small and cheap companies may be cheap for a reason! They flirt between turn around or on its way to their death. Basically, a small and value premium.
Some of the companies and region eventually go and die but the portfolio doesn’t die because of the constant reconstitution based on the strategy criteria.

I place a lot of emphasis on the last point (#3) because many retail portfolio manager to choose, to buy and sell, but not to be systematically rebalance or reconstitute the portfolio.

Our behavioural tendencies may also affect how we run the portfolio.

When I reviewed this result, I was wondering why the boutique value funds in the region cannot have the same set of return. A 9.2% p.a. return from 2016 and 2024 is pretty respectable if a value fund is able to take advantage of it.

I think the issue is:

Most boutique value funds in this region is based around Singapore, Hong Kong and China. They are more bottoms instead of top-down. They need to know what they own or in other words, there needs to be some sound fundamental basis for the stocks that they buy.

I think not being in India and Taiwan caused a significant tracking error if we were to measure their portfolio performance. But it is not without exception.

For example, from the period of 1st Jul 2015 to 31 Jul 2024, or the last ten years the performance is as such:

EM Index: 2.6% p.a.
EM Value: 1.8% p.a.
EM Small Cap: 5.5% p.a.
EM Small Cap Value: 6.0% p.a.

No surprises there.

Let’s go to Fundsupermart and filter the active emerging market fund with one of the best 10-year returns. It happens to be the Templeton Emerging Markets Smaller Companies, A USD fund with a 10-year return of about 4.8% p.a.

Not too shabby but this is like the second best fund out of the group with the best doing 6.6% (Schroder ISF Emerging Asia A Acc USD)

Whether they beat the market or not, this might run though your mind: “I pay a manager to try and target emerging markets smaller company and try as they might they might beat a systematic active strategy by a little. Most of the time, they end up falling short. So how much am I missing if I go with a systematic option instead of a more bottoms up approach?”

That is something for you to think about.

If you want to trade these stocks I mentioned, you can open an account with Interactive Brokers. Interactive Brokers is the leading low-cost and efficient broker I use and trust to invest & trade my holdings in Singapore, the United States, London Stock Exchange and Hong Kong Stock Exchange. They allow you to trade stocks, ETFs, options, futures, forex, bonds and funds worldwide from a single integrated account.

You can read more about my thoughts about Interactive Brokers in this Interactive Brokers Deep Dive Series, starting with how to create & fund your Interactive Brokers account easily.

I do have a few other data-driven Index ETF articles. These are suitable if you want to construct a low-cost, well-diversified, passive portfolio.

Systematic Passive Funds

This is a list of articles if you are more interested in investing in funds that track broad-based market capitalization-weighted indexes such as S&P 500, MSCI World, MSCI China etc.

You can check them out here:

Here are some supplements to sharpen your edge on low-cost, passive ETF investing:

Can You Better Time Your Annual Investment Base on Market Seasonality?

Systematic Active Funds

Those who wish to set up their portfolio to capture better returns believe that certain factors such as value, size, quality, momentum and low volatility would do well over time and are willing to harvest these factors through ETFs and funds over time, here are some articles to get you started on factor investing passively:

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Kyith

Kyith is the Owner and Sole Writer behind Investment Moats. Readers tune in to Investment Moats to learn and build stronger, firmer wealth foundations, how to have a Passive investment strategy, know more about investing in REITs and the nuts and bolts of Active Investing.

Readers also follow Kyith to learn how to plan well for Financial Security and Financial Independence.

Kyith worked as an IT operations engineer from 2004 to 2019. Currently, he works as a Senior Solutions Specialist in Insurance Start-up Havend. All opinions on Investment Moats are his own and does not represent the views of Providend.

You can view Kyith's current portfolio here, which uses his Free Google Stock Portfolio Tracker.

His investment broker of choice is Interactive Brokers, which allows him to invest in securities from different exchanges all over the world, at very low commission rates, without custodian fees, near spot currency rates.

You can read more about Kyith here.