ETF Expert

All Vanguard ETFs tend to cost less than competitor ETFs. And all things being equal, the lower your investment costs, the higher your returns.

But all things in the investment world are not equal. Not only do many ETFs track different indexes. But… even when they track the same indexes… there are undesirable outcomes such as tracking error. It follows that Vanguard vehicles are not always the best ETFs available.

That didn't stop the financial behemoth from recently introducing the Vanguard FTSE All-World ex-US Small-Cap ETF (VSS). It intends to provide exposure to foreign small-cap stocks from the developed and emerging world in a single diversified basket for the low expense of 0.38% annually.

The chief competitors for the new VSS venture are the SPDR S&P International Small-Cap Fund (GWX) and the WisdomTree International SmallCap Dividend Fund (DLS). The performance for these funds have been questionable in the massive worldwide stock selloff. What's more, there isn't a tangible difference between the two in bear market performance.

Clearly, the recently introduced Vanguard FTSE All-World ex-US Small-Cap ETF (VSS) will have an advantage on cost. Both the SPDR S&P International Small-Cap Fund (GWX) and the WisdomTree International SmallCap Dividend Fund (DLS) approach a gross expense ratio of 0.60% versus the proposed 0.38% for VSS.

Yet believe it or not, VSS may have advantages beyond cost.

Since dividends in WisdomTree's DLS are coming from the arena of long-established "value," most of the participants are from developed countries. The SDPR small cap version (GWS) may have growth and value entrants, but all of the corporations in the ETF are from the developed world. This gives the Vanguard FTSE All-World ex-US Small-Cap ETF (VSS) an opportunity to capture the spice of emerging market performance.

And there's more. Genuine diversification for an ETF typically requires two facets: (1) The ETF should have sufficient diversification across the number of companies in the basket… and Vanguard FTSE All-World ex-US Small-Cap ETF (VSS) reportedly has more than other international small cap funds with some 1600+ constituents. (2) The ETF should have a low correlation or a non-correlation with other ETFs in a particular portfolio. International small-caps have a historically low correlation with U.S. small-cap securities… and it is likely that the Vanguard FTSE All-World ex-US Small-Cap ETF (VSS) will be even more diversified due to the fact that it's the only international small cap fund that combines developed and emerging market corporations.

This is hardly a recommendation at this point in time; the fund's exceptionally low volume since trading began may lead to poor price execution in the bid/ask spread. Moreover, all stock assets, big and small, domestic and foreign, developed and emerging, have climbed at an amazing pace off the March lows. It may make more sense to look for a pullback in equities in general before committing new dollars.

One last thing. If you're not a believer in a Japanese renaissance, then recognize the 20% weighting that Vanguard FTSE All-World ex-US Small-Cap ETF (VSS) has there. I wouldn't be surprised to see the new VSS trade in a similar fashion to the WisdomTree Small Cap Japan Fund (DFJ) for a while.

If you'd like to learn more about ETF investing… then tune into "In the Money With Gary Gordon." You can listen to the show "live" or via podcast or on your iPod at this link.

Disclosure Statement: ETF Expert is a web log ("blog") that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Advisor with the SEC, may hold positions in the ETFs, mutual funds and/or index funds mentioned above. Investors who are interested in money management services may visit the Pacific Park Financial, Inc. web site.