Why This EM Strategy Reduced Exposure To Brazil And Taiwan

I often describe emerging market small caps as a surprisingly low-volatility way to access exposure to emerging markets. Investors think of small caps as high volatility, and that is particularly true for indexes such as the S&P 500 Indexcompared to the Russell 2000 Index, but it may come as a surprise that for emerging market equities, large caps have been more volatile over the last nine years than dividend-paying small caps.¹

As an example, the beta of the WisdomTree Emerging Markets SmallCap Dividend Index to the MSCI Emerging Markets Index has been .92 since its inception.²

Small Caps Usually Lag During a Commodity Rally

This year has been a year of strong commodity prices and commodity gains. Taken at face value and with no other information, I would say this should lead to small caps underperforming large caps, given their lower exposure. And this has been true for the MSCI Emerging Markets Index family—where small caps returned 9.08% year-to-date through 9/30, compared to large caps, which returned 16.02%, a 6.94% difference.³

Year-to-Date Performance

Year to Date Performance

Yet the WisdomTree Emerging Markets SmallCap Dividend Index, again a lower-volatility strategy with a beta below 1 since its inception, had returns that were 4 percentage points ahead of the large-cap MSCI Emerging Markets Index and 11 percentage points ahead of the MSCI EM Small Cap Index. What could explain this?

Country Allocations, but Now Taking Chips Off the Table

On a country basis, the WisdomTree strategy has been over-weight Brazil by a significant margin, and Brazil has been the strongest-performing market in emerging markets. Brazil has been a country with remarkably high dividend yields, and in our dividend-weighted approach, these companies have received an over-weight. After gains that averaged over 60% year-to-date, driven in part by a currency that was up over 21%, the Index is rebalancing and taking some chips off the table in these stocks, spreading them out to the other dividend payers in emerging market small caps.⁴

Relative Brazil Weight