After six consecutive and abysmal quarters of contraction, the economy of Europe has at long last returned to growth.
That’s a big deal.
Taken together, the 28 countries of the European Union constitute the largest economy in the world. And its year-and-a-half stretch of relentless recession has been a huge drag on global demand, hitting everything from Alcoa’s (AA) aluminum prices to sales of Big Macs at McDonald’s (MCD).
True, the upturn in gross domestic product was tiny, at just 0.4%. But it appears to reflect a turning point — one that the smart money is betting on big time.
As we noted recently, some terrific blue-chip European equities are on sale — and attracting lots of expert attention. Indeed, legendary value investor Bill Nygren scours the globe sussing out bargains suitable for his five-star Oakmark Global Select Fund (OAKWX) — and guess what? More than 40% of Nygren’s portfolio is currently allocated to European stocks.
But if you’re looking to squeeze some outperformance from a bet on European recovery, then an allocation to small-cap stocks makes a lot of sense. Not only do small caps outperform in a rising market, but they have fundamental tailwinds too.
After all, European small-cap stocks derive far more of their revenue from their own regions — as much as 75% t0 80% — than their multinational counterparts. And since most EU trade takes place between European countries and regions, small-cap companies should get outsized benefits from the return of growth.
The best way to gain cheap, diversified exposure to European small-cap stocks is through exchange-traded funds. Here are the best ETFs to bet on a return of European domestic demand:
WisdomTree Europe SmallCap Dividend Fund
- Ticker: DFE
- Total Assets: $117 million
- Expenses: 0.58%
- Yield: 3.43%
Performance Notes: This equity income ETF generates an attractive yield by any measure, but it’s especially generous when you consider that we’re talking about small-caps here, which usually plow cash back into expanding their businesses. DFE has delivered a total return of more than 20% so far in 2013, according to data from Morningstar, beating the Europe stock benchmark by 10 percentage points. Top holdings include Logitech (LOGI) and Drillisch (DRHKF).
iShares MSCI Germany Small-Cap Index Fund
- Ticker: EWGS
- Total Assets: $12.3 million
- Expenses: 0.59%
- Yield: 1.81%
Performance Notes: Germany is the locomotive pulling the European Union and eurozone out of recession. But even Germany needs demand to pick up from its neighbors and — happily — that appears to be the case. EWGS’s top holdings include Symrise (SYIEY), which sells flavors and fragrances to the food and perfume industries, and payments processor Wirecard (WRCDF). An uptick in the economy has helped EWGS deliver a total return of 17% for the year-to-date, outpacing the Europe stock benchmark by 7 percentage points.
iShares MSCI United Kingdom Small-Cap Index Fund
- Ticker: EWUS
- Total Assets: $9.2 million
- Expenses: 0.59%
- Yield: 2.83%
After Germany, the U.K. has been doing its own heavy lifting in pulling the EU out of its prolonged malaise. The British economy avoided the much-feared triple-dip recession, and that helped U.K. stocks go on a huge summer rally. EWUS has delivered a total return of more than 22% so far this year, beating the benchmark by about 12 percentage points. Oh, and that yield of more than 2.8% is awfully compelling for a portfolio of smaller companies. Top holdings include ASOS (ASOMF), an online fashion retailer, and homebuilder Taylor Wimpey (TWODF).
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.