As the global market crawls out of the recession, the rapid proliferation of narrowly-focused exchange-traded funds, which slowed as markets crumbled in the past two years, is beginning to gain momentum again.

One new trend to take note of: Providers are launching single-country small-cap ETFs. Through these funds, providers are offering exposure to domestic growth in specific emerging and developed countries, hoping to avoid the large cap companies that correlate closely with the still struggling global economy.

The trend garnered attention when Market Vectors launched its Brazil Small-Cap ETF in May, said Paul Justice, an ETF strategist at Morningstar Inc. [MORN]. The fund is considered successful, Justice said, returning 44.89% and 22.98% in the third and fourth quarters respectively, though it is down 7.53% year-to-date through March 22. The fund held $699.2 million in assets as of Feb. 28.

Much of the success is due to the fund's ability to avoid many of the materials companies and energy names that serve the global markets, Justice says. Instead, it moved into the small-cap sector, capitalizing on the emerging consumer and the health of Brazil.

That too is the thinking behind IndexIQ, the index-based alternative solutions provider that launched the first two in a series of single-country index-based small-cap ETFs on Tuesday. To Justice, IndexIQ is the first to follow Market Vectors in a trend that is here to stay.

“Throughout the year a lot of ETF issuers are going to come up with small-cap country exposure, partly because there’s a small cap idea that they give you more domestic stock exposure,” he said. “A lot of smaller countries have a few very large names on their stock exchanges that either tend to be utility companies, a large bank or a global titan that compete on a global level, so those are going to be large-cap and not necessarily giving you exposure to that domestic economy. And so now you have this new demand for small-cap exposure within those countries.”

The IQ Canada Small Cap ETF seeks to replicate the performance of the IndexIQ’s IQ Canada Small Cap Index, before fees and expenses. The index lost 61.54% in 2008, gained 116.44% last year and is up 2.24% year-to-date through Feb. 28.

Rich in natural resources, Canada climbed out of the economic crisis of 2008 and 2009 with significant strength, largely due to its hefty capital reserves and conservative lending practices, according to IndexIQ. It is the fifth largest oil exporter in the world and the second largest natural gas exporter, according to IndexIQ. The country also contains the second largest proven oil reserves. CNDA will offer exposure to the country’s rich oil and gas space.

The IQ Australia Small Cap ETF seeks to replicate performance of the firm’s IQ Australia Small Cap Index, before fees and expenses. The index lost 58.03% in 2008, gained 87.63% last year and is down 7.87% year-to-date through Feb. 28.

The only major country to avoid a recession by the technical definition (it experienced only one quarter of negative GDP, a recession is defined as two consecutive quarters of decreasing GDP), Australia has also proved its resiliency to the global downturn. It is one of China’s largest and fastest-growing trading partners, according to IndexIQ, and the world’s fourth largest producer of coal and gold.

Australia and Canada’s focus on the commodity space, however, could inhibit the success and popularity of the new ETFs, Justice said. In both countries, whether in small- or large-cap funds, commodity names dominate the portfolio, he says. Because of their small populations, as compared to the wealth of natural resources they offer, both economies are largely tied to the performance of such resource stocks.

Small-cap funds in these countries “don’t give you the small-cap exposure the [BRF] did, and so I’m not so sure that they will resonate with investors the way the small-cap Brazil ETF did,” Justice said. “Plus, there are similar shared risk factors for Australia and Canada.”


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