What is SCHC? (Pros, Cons, and Strategies)

Investing in international markets can be a great way to diversify your portfolio, and one of the tools investors use is SCHC. For those unfamiliar, SCHC stands for the Schwab International Small-Cap Equity ETF. Unlike domestic, large-cap-focused ETFs, SCHC provides exposure to small-cap companies outside the United States. This blog post will explore what SCHC is, its pros and cons, and some strategies for incorporating it into your portfolio.

What is SCHC?

SCHC is an ETF that seeks to track the performance of the FTSE Developed Small Cap ex US Index. This fund primarily focuses on small-cap companies located in developed markets across the globe, excluding the United States. These companies are typically characterized by their smaller market capitalization compared to large-cap companies, offering unique growth opportunities distinct from those commonly found in larger, well-established U.S. businesses.

Key Features of SCHC

• Exposure to Developed Markets: SCHC provides exposure to small-cap companies in developed markets such as Japan, the United Kingdom, and Canada, among others.
• Diverse Sector Allocation: The ETF spans various sectors, including industrials, consumer discretionary, and technology, providing broad diversification.
• Liquidity and Trade Volume: While focusing on small-cap companies, SCHC maintains sufficient liquidity to facilitate trading and minimize the bid-ask spread.

By offering exposure to small-cap companies outside the United States, SCHC enables investors to tap into global growth opportunities that may not be available domestically.

SCHC Composition

SCHC is widely diversified, holding hundreds of small-cap international stocks. Some of the top holdings include companies like Constellation Software Inc. (Canada), Kion Group AG (Germany), and Softcat PLC (United Kingdom). The fund aims for comprehensive geographic and sectoral diversification, reducing the risk related to any single country or industry.

Pros of SCHC

Enhanced Diversification

One of the primary benefits of investing in SCHC is enhanced diversification. By holding international small-cap stocks, investors reduce their dependence on U.S. market performance. This broader diversification can help mitigate risk, particularly during periods of domestic market volatility.

Growth Opportunities

Small-cap companies often have higher growth potential compared to their large-cap counterparts. Given that SCHC focuses on international small-caps, it opens doors to untapped growth opportunities in burgeoning markets that might not be accessible through U.S.-focused funds.

Cost-Effective Access to International Markets

SCHC provides a cost-effective way to gain exposure to international small-cap stocks. With an expense ratio of 0.11%, SCHC offers a lower-cost alternative to many actively managed international funds, making it an efficient way to diversify your portfolio.

Cons of SCHC

Higher Volatility

Small-cap stocks generally exhibit higher volatility compared to large-cap stocks. Consequently, SCHC may experience more significant price swings, which could be unsettling for risk-averse investors. It's important to factor in this increased volatility when considering an investment in SCHC.

Currency Risk

Investing in international assets exposes investors to currency risk. The performance of SCHC can be significantly impacted by fluctuations in foreign exchange rates. A stronger U.S. dollar could negatively affect the returns on the ETF’s holdings, diminishing your overall gains.

Limited Dividend Income

Unlike dividend-focused ETFs, SCHC is less likely to provide substantial dividend income. Small-cap companies often reinvest profits to fuel growth instead of paying out higher dividends. Therefore, SCHC may not be the best choice for income-focused investors.

SCHC Investment Strategies

Long-term Growth Strategy

Given its focus on small-cap stocks, SCHC is best suited for long-term investors looking to capitalize on potential growth over an extended period. The growth opportunities in international small-cap markets may take time to materialize, thus requiring a longer investment horizon to fully benefit.

Investors who allocate a portion of their portfolio to SCHC should be prepared to hold the ETF for at least 5-10 years. This strategy allows time to ride out short-term market fluctuations and benefit from the compounding growth of small-cap companies.

Portfolio Diversification Strategy

SCHC serves as an effective tool for diversifying a portfolio that might otherwise be concentrated in U.S. equities. By including SCHC, investors gain exposure to different economic cycles, political environments, and market dynamics, helping to spread risk across various fronts.

Consider allocating 5-10% of your portfolio to SCHC to supplement a core portfolio of large-cap and mid-cap U.S. stocks. This allocation can enhance overall portfolio diversification and reduce volatility through geographic and market diversification.

Risk Management Strategy

While SCHC introduces higher volatility, strategic application of risk management measures can help mitigate potential downsides. Investors may consider pairing SCHC with lower-risk asset classes such as bonds or large-cap domestic stocks to balance the overall risk profile of their portfolio.

Utilizing modern portfolio theory principles, investors can achieve an optimal mix of risk and return by carefully balancing their exposure to SCHC with more stable investment options.

Conclusion

SCHC offers a unique opportunity to diversify your portfolio with international small-cap stocks. While there are inherent risks associated with higher volatility and currency fluctuations, the potential for growth and enhanced diversification makes SCHC an appealing option for long-term investors. By employing thoughtful investment strategies, you can effectively incorporate SCHC into your portfolio, optimizing your risk-return balance.