Emerging market exchange-traded funds were a huge story in 2017, but many investors may not have noticed.
After all, the big headlines last year always seemed to be talking about President Donald Trump, or the broad-based rally in stocks or sometimes the two at the same time. Emerging markets were, for the most part, simply not as interesting.
That’s not a terrible thing, since simply owning U.S. equities was a great idea last year. Domestic large-cap stocks were up about 20% as measured by the S&P 500.
However, we shouldn’t overlook the fact that global markets as a whole did very well — and some emerging markets ETFs did even better than domestic stock funds did. The broad Vanguard Total International ETF (NASDAQ:VXUS) was up about 25% and the popular iShares FTSE/Xinhua China 25 Index ETF (NYSEARCA:FXI) was up about 37%.
That is likely to continue on the New Year, with Goldman Sachs recently forecasting double-digit growth for the popular MSCI emerging markets index driven by a “younger and friendlier” credit cycle.
Furthermore, it seems very likely that the fast money will start moving out of U.S. stocks and into alternatives. After all, Dow 25,000 is a great milestone but Wall Street is defined by trend-chasing — not buying and holding forever. While I fully expect America’s economy to stay strong and the U.S. stock market indexes to finish 2018 with some nice gains, it seems reasonable for investors to dabble in other places to find alpha after the great performance of the last 13 months or so.
There are no shortage of index funds out there to play emerging markets, of course, including the two funds above.
However, I like the lesser-known Vanguard FTSE All World Ex-U.S. Small Cap ETF (NYSEARCA:VSS). The fund was up about 30% last year, significantly more than the S&P 500 and above a bunch of other global ETFs to boot.
Here’s why I like it in 2018, too.
Small Cap Bias: I’m not incredibly interested in large international plays, because multinationals in Europe and Japan aren’t much different than multinationals in the U.S. I mean, the difference between the big-picture trends behind Europe’s Unilever PLC (ADR) (NYSE:UL) and America’s Colgate-Palmolive Corporation (NYSE:CL) are pretty much the same. The growth potential and local economics of small caps are much more interesting — and differentiated from U.S. stocks.
Emerging Markets Flavor: The fund is anchored in Europe, with about 38% of the portfolio’s assets located there. However, emerging markets make up a good 20% of the portfolio as well. This is enough to make this fund a good tactical bet on emerging markets growth without taking on too much risky on these volatile regions.
Incredible Breadth: Many emerging market funds have a few hundred holdings, but the VSS ETF boasts over 3,500 components. That ensures that one dud won’t sink your performance — something that is a real risk when you play emerging markets and small caps at the same time.
Dirt Cheap: At just 0.13% in annual expenses, the fund costs you a measly $13 for every $10,000 invested. Not only is this inexpensive in a vacuum, it’s incredibly cheap considering you get access to thousands of small international companies that you may never be able to hold a stake in otherwise.
Those reasons are a compelling enough reason for me to pick VSS as my single-best ETF selection for 2018. But bigger picture, even investors looking for a holistic and diversified approach to the markets should consider adding this international fund regardless of their tactical bets.
That’s because you simply won’t get a better way to truly diversify your portfolio than this single fund. In one Vanguard ETF, you get emerging markets PLUS developed global markets outside America PLUS small cap exposure in those markets.
I never understand why folks purchase a Nasdaq 100 index fund or a tech sector fund when they also own an ETF benchmarked to the S&P 500. As a market-cap weighted index, you’re already heavily exposed to large cap tech thanks to the biggest positions being Apple Inc. (NASDAQ:AAPL) at No. 1 at almost 4% of the S&P index, Microsoft Corporation (NASDAQ:MSFT) at No. 2 with almost 3% and Amazon.com, Inc. (NASDAQ:AMZN) at No. 3 with about 2%. Throw in Facebook Inc (NASDAQ:FB) and two classes of shares for Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) and these five large cap tech stocks account for just shy of 14% of the entire S&P 500 portfolio!
If you’re chasing outperformance in 2018 and truly believe in these stocks, then just buy the individual names. But if you’re looking to play ETFs and diversify, don’t bias yourself more towards domestic large caps than you already are.
Instead pick VSS. It’s the perfect one-stop shop to make any portfolio truly diversified with one holding.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. Write him at email@example.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not hold a position in any of the aforementioned securities.