iShares MSCI EAFE Small-Cap ETF- SCZ

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On this episode of the “ETF of the Week” podcast, Tom Lydon discussed the iShares MSCI EAFE Small-Cap ETF (SCZ) with Chuck Jaffe of “Money Life.” The pair talked about several topics regarding the fund to give investors a deeper understanding of the ETF overall.

SCZ ETF

Chuck Jaffe: On point for today, and the expert to talk about it. Welcome to the ETF of the Week. Yes, it’s the ETF of the Week, where we get the latest. Tom Lydon, vice chairman of VettaFi. They have a full suite of tools that are going to help you become a better, smarter, savvier investor in exchange traded funds. Check out VettaFi.com for more information. Tom Lydon, It is great to chat with you again. Happy Thanksgiving.

Tom Lydon: Happy Thanksgiving, Chuck. Thank you.

Chuck Jaffe: Your ETF of the Week…. ?

Tom Lydon: It’s the iShares MSCI EAFE Small-Cap ETF (SCZ).

Chuck Jaffe: Tom, small-caps for most of the year have struggled, and of course, it’s been a market led by big domestic stocks. But small-caps are responsible for the recent rally. And when I look at a chart of this one, well, this one at any moment now seems ready to cross its 200-day moving average. So is this simply a trend play or is there more to it than that?

Tom Lydon: Well, Chuck, for the last year, we’ve talked about not only the trends. We’ve also talked about diversifying away from the S&P 500 and most importantly, the top 10 stocks in the S&P 500 that have been the lion’s share of the performance of that 10% that we’ve seen so far in the S&P 500 this year. But when we talk about other areas of the market, small-caps have been unloved and unloved for five or six years now compared to large-caps.

But that doesn’t mean they don’t warrant interest or your attention. When you look at diversification in the U.S., there’s a lot of opportunity in small-caps. But when you look overseas in areas like Europe, Australia, Asia, and the Far East, there are a lot of good opportunities and a lot of profitable companies. And these stocks are downright cheap. When you look at the P/E ratio on this ETF, it’s about 11.

And rarely do you see a diversified offering of stocks so inexpensive. So that, along with the fact that, yes, we’re just about to cross the 200-day average on this ETF, if you have some money on the sidelines and we know you do — statistically most advisors have a chunk of cash. Most individual investors have a chunk of cash.

And you’re just waiting for the water to get a little bit warmer before you go back in. The question is, when do you go back in? What do you buy, and how long do you own it? This is maybe one of those opportunities to get into an unloved area that’s inexpensive and could continue to do well off of the low that we saw just a month ago.

Chuck Jaffe: That said, you know, you have long pointed out that people do not have enough money invested internationally. And then you’ve got that decision of, where do you want to go with it? But international small-caps, well, do you think that the play there is more about getting the real diversification? Because when people aren’t going for internationals, they’re getting their diversification by owning U.S. multinationals.

The Magnificent Seven are seven domestic stocks, but they do business around the world. Is part of this that if you’re going to take your money and get boots on the ground overseas, that small-cap is the case where you’re going to get much more diversification, because smaller companies are much less multinational?

Tom Lydon: Well, they are. However, these companies that are domiciled in these foreign countries are pure-plays, and they’re going to benefit from mostly business within their regions. Most of them aren’t shipping overseas. So they are specific to those regions. And when the market’s been challenged, the U.S. has gotten the lion’s share of new business.

One other important point, though, as we keep talking about the S&P 500, most importantly, the Magnificent Seven, the S&P right now has a P/E ratio of about 21 — above average on the expense side. But when you look at the Magnificent Seven, the P/E ratio collectively of those is in the high 30s. We’re surveying advisors all the time, Chuck. Their biggest fear today — and again, nine months ago — was inflation and rising interest rates.

The biggest fear today is market valuation fluctuation and risk, and most of that’s pointing to the Magnificent Seven. So if you look at your portfolio or if you’re managing money, probably you’ve got a high correlation in your equity area of the market to the S&P 500. Start looking outside of that. Start looking at areas that really, a month ago, were doing, have done, just as well or better than the S&P 500.

And if that trend continues and it goes above its 200-day average, this is just maybe one of those opportunities that may be developing a new trend for a while. Not sure there’s anything guaranteed. But it’s so much more advantageous to be buying in when things are relatively low compared to just a few years ago. And relatively a lot less, a lot less expensive.

Chuck Jaffe: Here we are talking about trends. And one of the interesting things here, normally when we’re talking trends, it’s all about the 200-day moving average. Do you want to be a trend follower? But when you look at what has happened historically, international small-cap is one of the areas where a lot of people who look at the ETF space will say that’s where active management can add some benefit.

You’re going into a more esoteric area. Now, if you believe that this is an area that’s about to take off and you want representation, you kind of want the broad index fund. But if you’re going, “Oh, wait, hold it; I want extra oomph,” you might want to go with an active manager or a more active manager.

And we’ve seen the development of a lot of actively managed ETFs. I’m curious, because obviously, you like the space. That’s what we’ve been talking about. But was there a reason in this case why you said, “I’m going to go broad and more index as opposed to going, let me go find an international small-cap manager who’s a specialist in that one area?”

Tom Lydon: Well, this ETF also has sustainability characteristics that are specific to the underlying constituents, Chuck. That’s also important. There are a lot of companies out there that do well over an extended period of time. Small-cap companies — not all of them last to make themselves into midcap or large-cap. So there are certain metrics that iShares and MSCI put together to create this index.

They have to meet these characteristics. And periodically the index is adjusted, at least on an annual basis. We again put these stocks through the sausage grinder. And not all of them come out the other end. So you make some changes in that index as well. And not just with the names, but also with the weightings.

So even though this is not actively managed, it really is put up to the test, at least on an annual basis. That’s to be sure each individual stock meets these certain characteristics. That’s really good because you’ve got the diversification, you’ve got the valuation, and you’ve also got representation with other areas of the world that frankly, we’ve had home country bias here.

Chuck, you and I talk about that all the time, where we’ve got too much invested just in U.S. stocks. And 55% of global market capitalization happens outside of the U.S.

Chuck Jaffe: And this is a way to expand how much of the market capitalization you have. It’s the iShares MSCI EAFE Small-Cap ETF (SCZ), the ETF of the Week. Tom Lydon, great stuff, as always. See you next week.

Tom Lydon: Thanks, Chuck.

Chuck Jaffe: The ETF of the Week is a joint production between VettaFi and Money Life with Chuck Jaffe. That’s me. Why don’t you check out my hour-long weekday podcast at moneylifeshow.com or wherever you find good podcasts. To learn more about ETFs, there’s no better place than VettaFi.com. They have great tools for you there. VettaFi is on Twitter or X @Vetta_Fi. @TomLydon my guest is on Twitter, as well. The ETF of the Week is here for you every Thursday. Why don’t you make yourself a subscriber so you don’t miss an episode? We’ll see you next week. Happy Thanksgiving. Happy investing, everybody.

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