ETFs are a great way for most Belgians to build their wealth and improve for their financial future. But there are thousands of ETFs available in the market, and more are coming out every week. Among these, small cap ETFs have emerged as a noteworthy choice for investors looking to diversify their investments. Small-cap ETFs focus on companies with smaller market capitalisations, which often offer higher growth potential compared to their larger counterparts. We will highlight the top small-cap ETFs for Belgian investors. We'll also discuss the risks associated with concentrating your investments too narrowly in one area and suggest strategies to spread your investments more effectively.
Why small-cap ETFs can be a good investment
Small-cap companies, defined as those with smaller market capitalisations, often have greater growth potential compared to larger and more established companies. These companies are typically in the early or developmental stages of their business and have the potential to grow rapidly as they capture new markets or innovate. The market capitalisation of companies considered small-cap is usually between $300m and $2bn.
By investing in small-cap stocks, you can benefit from the size effect, which gives greater risk-adjusted returns for smaller stocks.
You can see the size effect in practice by comparing the performance of the MSCI World index with a small-cap index, the MSCI World Small Cap index. Whereas the larger stocks in the MSCI World index have delivered an average return of 5.3% per year since 2001, the MSCI World Small Cap has yielded an average annual return of 7.7%.
How to select the best small-cap ETFs
There are some criteria we should stick with as a Belgian investor.
Follows an index
The style of investing based on index funds, also called passive investing, is a superior strategy for most people. There’s no need to spend time analysing individual companies and stocks, you can just follow an index of companies or governments.
Accumulating fund
From a taxation point of view, accumulating funds are preferred over distributing funds to avoid paying a 30% tax on dividends.
Low cost
Most ETFs are already low-cost compared to active funds. But when we have the choice between several ETFs tracking the same index, we prefer a cheaper one (all other things being equal). The cost is measured by the total expense ratio (also known as the TER).
Domiciled in Ireland or Luxembourg
Both countries have special tax treaties with many countries around the world. This makes it fiscally advantageous to invest in ETFs domiciled in Ireland or Luxembourg. You can recognise these by their ISIN code that starts with "IE" (Ireland) or "LU" (Luxembourg).
Diversified across many countries and sectors
Diversification is important when investing because it helps to reduce the overall risk. The basic idea behind diversification is to avoid having all your eggs in one basket, so that the impact of a single negative event is reduced. For example, if you only in one country and that country experiences an economic crisis, your entire investment portfolio will be negatively impacted. However, if you had invested in an ETF that diversifies across different countries, the impact of the downturn of that one country on the portfolio would be less severe.
Size matters
Larger funds are less likely to be shut down. A reasonable guideline is to consider only ETFs that have at least €100 million under management. This is especially important as ETFs that focus on a particular sector tend to be more niche and therefore smaller.
Physical replication
Physical replication is preferred over synthetic replication to reduce third-party risk.
The best small-cap ETFs for Belgians
We selected only accumulating ETFs of sufficient size and that physically replicate their index.
iShares MSCI World Small Cap (IE00BF4RFH31)
ISUN is one of the most popular small-cap ETFs available to Belgians. Its popularity stems from the fact that it's very diversified with 3,371 companies as part of the index. 60% of the companies are based in the United States, but with a strong diversification across sectors. The ETF is managed by iShares (Blackrock), costs 0.35% annually and tracks the MSCI World Small Cap index. Based on historical data of the index, it has returned an average 7.7% per year since 2001.
Xtrackers MSCI Europe Small Cap (LU0322253906)
XXSC is a popular ETF for investing solely in European small-cap companies. It tracks the MSCI Europe Small Cap index and is composed of companies from all major European countries including the UK, Sweden, Switzerland... and Belgium. It includes 924 companies and covers all sectors. The companies are reviewed on a quarterly basis to see if they still match the criteria.
The ETF is managed by Xtrackers and with a TER of 0.30%, it's slightly cheaper than the previous iShares ETF. It's the largest ETF tracking European small caps and has returned an average 7.8% per year since 2001 based on historical data of its index.
SPDR MSCI Emerging Markets Small Cap (IE00B48X4842)
Just like the previous ETF XXSC focuses on European small caps, this SPYX ETF from SPDR focuses on the smaller stocks in emerging markets. Through the MSCI Emerging Markets Small Cap index, you're investing 2,015 companies spread out across countries which are considered "emerging: Taiwan, China, Brazil...
The stock markets in emerging countries are less accessible, which translates to a higher annual cost of 0.55% per year. Based on the historical data of the index, it has returned an average 5.1% per year since 1994.
SPDR MSCI USA Small Cap Value Weighted (IE00BSPLC413)
This ETF by SPDR tracks the MSCI USA Small Cap Value Weighted index. It invests in almost 1,800 American small-cap companies, but emphasises stocks with lower valuations.
By excluding small-cap growth companies, which have high valuations and comparatively low profitability, we can profit more of the size premium. This is because it turns out that small cap growth stocks are responsible for the underperformance and statistical unreliability of the asset class as a whole.
The ETF is managed by State Street and costs 0.30% per year. Based on the historical performance of the index, it has returned 12.2% annually since 1994.
Conclusion: which small-cap ETF do I go for?
It has been demonstrated that small-cap growth stocks fail to deliver the premium associated with the size factor. In an ideal world, there would be a globally diversified small-cap ETF that focuses on value stocks and excludes growth stocks. Unfortunately, such an ETF is not yet available to Belgian individual investors.
The SPDR MSCI USA Small Cap Value Weighted ETF (IE00BSPLC413) emphasises value stocks, but is concentrated in the US. So if you prefer more diversification, we suggest the iShares MSCI World Small Cap ETF (IE00BF4RFH31) is the best option.
Downsides of investing in small-cap ETFs
Investing in small-cap ETFs, while offering potential for growth, does have some downsides.
Small-cap stocks are riskier
Small-cap stocks are generally more volatile than their large cap counterparts. This means that their prices can experience wider fluctuations over short periods, which can lead to significant gains but also substantial losses. This volatility (moving up and down) is due to the smaller market capitalisation, which makes these stocks more sensitive to market movements and investor sentiments.
Small companies have limited resources to grow
In general, small-cap companies often have fewer resources compared to larger companies. This can make them more vulnerable to economic downturns, changes in market conditions, or financial stress. Limited resources can also impact a smaller company's ability to invest in growth opportunities or weather prolonged periods of hardship so it adds more risk towards your investment.
Small-cap growth stocks should be excluded
Small-cap growth stocks do not deliver the higher risk-adjusted returns of small companies. But a globally diversified value small-cap ETF does not exist for Belgians. So at this moment, the full size premium cannot be leveraged.
Curvo, an easier way to invest globally
At Curvo, our investment philosophy is rooted in the power of diversification. Unlike the narrow focus of small-cap ETFs, the portfolios are designed to harness the growth potential of companies of all sizes.
Global outlook
We go beyond the confines of a single market or region, spreading investments across many countries around the globe. This global diversification helps mitigate risks associated with investing heavily in small cap companies or specific regions that might be volatile or underperform.
Spread out across sectors and industries
The portfolios are carefully constructed to include a wide range of sectors and industries. This ensures you're invested in both the leaders of today and the emerging leaders of tomorrows.
Large companies are also included
While we recognize the growth potential of small companies, the portfolios also include mid and large cap companies. This blend allows investors to capture the innovative spirit of small caps while balancing the stability and reliability of larger firms.
Automate your investments
Set up your monthly plan in the Curvo app and automatically invest every month. This way, get peace of mind that your money is working for you. Saving is easy when it's automated!
Invest for the long term
Curvo's buy-and-hold strategy is aligned with a long-term perspective, embracing the notion that while investing might not be flashy, it should be steady and reliable. Investing through Curvo means an investment in a broad and balanced portfolio, including exposure to over 7,500 companies across various sizes and without the risk of over-concentration in any single area.
Find out how Curvo works.
Summary
Small-cap ETFs stand out as a component of a diversified investment strategy, particularly if you want to expand beyond traditional assets. With their potential for higher growth, these ETFs offer an attractive entry point into the world of companies that, despite their smaller size, may be on the brink of expansion. Albeit the size effect means you can achieve higher returns through small caps, it comes with a higher degree of volatility and risk, underscoring the importance of a balanced approach to investing your savings. Furthermore, it is necessary to exclude small-cap growth stocks to fully benefit from the size premium, but no such ETF is available to Belgian individual investors. Investing in small-caps through a global ETF or one of the portfolios offered through Curvo may be a more sensible approach.