Our favourite ASX small cap ETFs
Gold rated funds to watch amidst interest rate cuts.
Mentioned: Vanguard MSCI International SC ETF (VISM), Perpetual ESG Australia ShareETF E (GIVE), DFA Australia Limited (DGSM)
Small caps are back in the spotlight after Director of Manager Research, Eva Cook, suggested that the asset class may be set to shine bright in 2025. This comes after the trajectory of national interest rates finally shifted with the RBA dropping the rate by 0.25%.
Aussie small caps have weathered a tough few years of returns in comparison to their larger ASX counterparts due to structural nuances that aren’t present globally. Unlike Australian small companies, global smaller caps have historically outperformed relative to large companies over the long term. I previously published an article detailing the considerations of investing in small caps here.
Nevertheless, the global small cap market is fraught with many incoherent risks that foster inefficiencies and has led to wide return dispersion. Traditionally, this would favour an active management approach, but the evidence points to the contrary. We fund that an active manager lacks the scale to deploy analysis across a broad set, thus putting them at a disadvantage relative to passive managers.
Given the single stock risk is higher in small caps, the time required to actively manage and research a portfolio of small caps may not be for the average investor. A collective investment vehicle like an ETF might be preferable.
Our gold medalist ETF picks
Vanguard MSCI International Small Companies Index ETF (VISM)
VISM tracks the MSCI World ex Australia Small Cap Index which represents 22 developed markets and 4000+ constituents. The fund offers an unbeatable cost proposition over active and passive peers alike, and it has highly efficient access to the developed market small caps.
The index is composed of majority US stocks accounting for ~62% of the MSCI World ex Australia Small Cap Index. The benchmark also has significant stakes in healthcare, industrials and technology with only a modest allocation to basic materials providing diversification for Australian investors.
Since its inception, VISM has stayed ahead of an average manager on an absolute risk-adjusted basis. Notably, the portfolio has also proved more resilient than its peers in market downturns. Amid weak global equity markets in 2022, the strategy posted a 12.8% loss compared to 19.8% for the average category peer.
The trailing return for the five years through January 2024 saw the portfolio outperform the average category rival by 0.54% net of fee annually. However, Morningstar cautions investors against extrapolating past performance noting that small caps are higher volatility and passive funds lack a protection lever against this volatility.
What we think: With the lowest investment management fee on the list, VISM is an excellent choice for Australian investors seeking cost-effective and efficient exposure to the global small-cap markets.
Perpetual ESG Australia ShareETF E (GIVE)
Gold-rated fund GIVE invests in quality stocks with a value tilt and ethical focus. This strategy has shown a consistent bias towards mid and small cap stocks due to the ESG screening process, combined with Perpetual’s quality and value filters significantly reducing the investible universe among larger companies.
The portfolio is comprised of domestic equities, with ~70% of its composition being in mid and small caps. The approach favours names with good earnings visibility and tenable levels of debt, meaning the portfolio has lower P/E multiples and lower debt/equity characteristics compared with the ASX Small Ordinaries. Unlike ESG-focused peers that typically have heavy technology investments, Perpetual's value process typically underweights this sector and overweights financials, consumer discretionary, and healthcare names relative to the category index.
Ethical screens prohibit the inclusion of investing in certain substantial index holdings such as BHP for uranium mining and thermal coal, as well as Coles for alcohol and gaming revenue. Notable names in top holdings include Telstra Group Ltd, Westpac Banking Corp and Medibank Private Ltd.
Performance has been strong under portfolio manager Nathan Hughes’ tenure. Since his tenure (5 years), the fund has delivered an annual return of 10.5% versus the category index of 5.3% and category average of 9.5%. Furthermore, they have achieved this strategy at a lower level of volatility (std. 12.51).
The annual fee is also attractive relative to its peer group, with a base fee of 1.18% on the managed fund and 0.65% for the GIVE exchange-traded fund.
What we think: For investors wishing to build their portfolio with ESG considerations, GIVE is a compelling offering thanks to its knowledgeable portfolio manager and well-designed approach.
Dimensional Global Small Company Active ETF (DGSM)
DGSM is a small-cap global equity strategy based on factor investing, with an opportunity set orientated towards size, value (measured by the price/book ratio), and profitability. The fund captures ~4,400 stocks with a small cap and value tilt at an annual fee of 0.65%.
This approach is motivated by academic research demonstrating that these characteristics have historically been associated with higher returns. Consequently, the portfolio is overweight in stocks with lower valuations, smaller market caps, and higher profitability.
In a market segment considered to be inefficient enough for active managers to add incremental value, the success of the strategy has been notable. As market conditions turned unfavourable in 2022, value stocks outperformed the growth segment and was able to protect downside movements far better than the category index and average. The large portfolio diversifies away from stock and firm-level risks meaning that relative fund performance largely depends on the targeted factors. Outperformance has remained consistent with a 5 year trailing return of 10.7%, rivalling the category average and index return of 10% and 0.3% respectively.
Portfolio composition skews towards industrials (20%) and financial services (17%) with a 72% skew to the US which is overweight compared to the average peer. Excluding the most expensive and unprofitable companies means the resulting strategy is overweight in micro-caps (14.8% vs 2.9% category average) and has negligible exposure to large caps (0.6% vs 7.14% category average).
What we think: DGSM is excellent investors seeking a well-diversified small-cap portfolio encompassing various developed-markets ex-Australia. Using a proven factor-based methodology at a competitively low fee, the fund continues to earn our conviction on its ability to outperform its Morningstar Category index over the long term.
Thinking of buying an ETF? Access our best resources for diving into the ETF market.
