We have qualitatively reviewed this strategy and reaffirmed its Above Average People and Process ratings. The following text is from May 1, 2023.

Schwab International Small-Cap Equity ETF’s SCHC low fee and diversified portfolio should prove tough to beat. It earns a Morningstar Analyst Rating of Silver.

This fund tracks the FTSE Developed Small Cap ex US Liquid Index. It holds small-cap stocks listed in more than 20 developed markets outside of the United States, including Canada and South Korea. It weights holdings by market cap, an efficient approach that harnesses the market's consensus opinion of each stock’s relative value. Stocks that grow in size take up a larger share of the portfolio, while struggling companies take on a less important role as their price drops.

The managers may not hold every stock in the index. They may choose to exclude certain stocks that are expensive to trade, which helps avoid trading stocks that are expensive to transact; a minor detail that helps set this fund apart.

Despite not fully replicating its benchmark, the portfolio still effectively diversifies away any single-stock risk with more than 2,000 holdings and just 5% of assets concentrated in the top 10, as of March 2023.

Minimizing stock-specific risk does not minimize country-specific risk. The fund can be susceptible to the movements of the sometimes-volatile local markets that the portfolio features since small-cap stocks tend to be better connected to their local markets than their larger counterparts. Recently the fund held around a 20% stake in Canadian stocks. Typical peers usually allocate less than 7% of their portfolios to Canadian equities. This gives that market greater influence on overall fund performance.

Energy and materials companies are common in Canada, which increases this fund’s exposure to stocks from those sectors. Those sectors are also tightly connected to broader commodities markets. This means that when commodities markets falter, this fund can be more susceptible to price swings of oil and metals, for example.

Heavier stakes in stocks linked to commodities has hurt performance. The fund lagged the foreign small/mid-blend Morningstar Category average by 62 basis points per year over the 10 years through March 2023. Most of that deficit occurred between 2011 and 2015, when commodities prices broadly declined and hurt businesses closely tied to them. While these market segments can hold performance back sometimes, fees usually have a larger long-term impact. The fund ranks among the category’s cheapest, which should prove a reliable edge over the long run.

Analyst Rating

Low-cost, but risky choice.

Analyst

Zachary Evens

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We have qualitatively reviewed this strategy and reaffirmed its Above Average Process rating. The following text is from May 1, 2023.

This fund tracks the FTSE Developed Small Cap ex US Liquid Index. Its broad scope promotes diversification, and market-cap weighting helps rein in turnover. It earns an Above Average Process Pillar rating.

Above Average

Process

We have qualitatively reviewed this strategy and reaffirmed its Above Average People rating. The following text is from May 1, 2023.

Schwab has strengthened its equity index management team over the past few years, under the leadership of Chris Bliss. It earns an Above Average People Pillar rating.

Bliss leads Schwab's equity index team. Since joining Schwab from BlackRock in 2016, Bliss has strengthened the team by increasing specialization and automating more of the managers' workflow. This allows the managers to spend less time on routine tasks and helps them better identify and resolve issues that require their attention. Chuck Craig and David Rios join Bliss as named managers on this fund. Jane Qin was previously named as manager on the fund, but she left to oversee portfolios in Schwab’s personalized indexing effort in June 2022. The named managers have support from associate managers who help the team prepare for index rebalances.

The team looks for ways to slightly improve returns by handling some corporate actions differently from the index. The managers can take advantage of those opportunities when they occur, under tight tracking-error constraints.
Schwab compensates its managers based on tracking error and compliance with risk management, which helps align their interests with investors'.

People

Under new but familiar leadership, Schwab Asset Management Solutions maintains its Above Average Parent Pillar rating. 

After the former Schwab CEO was named president of parent Charles Schwab Corporation in 2022, Omar Aguilar, a Schwab CIO since 2011, was promoted to CEO while retaining his CIO role. Under Aguilar's leadership, Schwab remains focused on core-oriented strategies: More than 95% of the firm's fund assets under management are in low-cost index products that are suitable for the biggest portions of investors' portfolios. Index-tracking remains are par with the best teams in the business.

Recent strategic initiatives show a desire to grow in an increasingly competitive landscape. Forays into direct indexing—which customizes separate accounts through tax-loss harvesting, values-based requests, or other client preferences—as well as some new launches, such as Schwab Municipal Bond ETF, fit the firm's strategic focus and are natural extensions of its capabilities. However, other recent launches in more-niche asset classes, including Schwab Crypto Thematic ETF, contrast previous refusals to enter trendy markets. 

Schwab benefits from its association with its parent's brokerage business. This arrangement and efficient operation allow funds to grow quickly and keep fees in line with larger competitors. Historically, Schwab has been quick to match competitor fee cuts and now sports a 0.09% asset-weighted average fee across its mutual funds and ETFs.

Parent

Schwab International Small-Cap Equity ETF

SCHC tracks a market-cap-weighted index of the smallest 10% of companies in the FTSE Developed ex-US Index.

SCHC offers broad, low-cost exposure to international small-caps, an area currently trading at attractive valuations that could benefit from global supply chain diversification and a weaker U.S. dollar. However, the fund's passive, index-hugging approach has drawbacks, including the risk of holding unprofitable companies and over-diversification that may impair returns. Despite lackluster returns, we maintain a Hold rating on SCHC, recognizing the attractive valuations and potential long-term tailwinds for international small-caps.

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