International stocks found their respective grooves in 2025, and they're on track to outperform U.S. equities. The significantly weaker U.S. dollar and other nations' central banks beating the Federal Reserve to the interest rate-cutting punch are among the tides that have been lifting the international equity boat this year.
With 2026 right around the corner, retail investors who missed out on some or all of this year's international stock rally may be wondering if next year will bring more of the same. It's certainly possible, and the small-cap segment of the international market could be the right way to get your investing passport stamped.
That's why I'm eager to allocate some funds to the Vanguard FTSE All-World ex-US Small-Cap ETF (VSS +0.01%) now. So eager, in fact, that this is the second time this month I've written about this exchange-traded fund (ETF), but it's worthy of further examination, particularly when new catalysts come to light.
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This small-cap ETF has big potential
As of Nov. 12, this international ETF was up 26.2% year to date -- a statistic made all the more impressive when considering that two of the primary U.S. small-cap funds -- the broad iShares Russell 2000 ETF and the more-focused iShares Core S&P Small-Cap ETF -- are only up by about 11% and 5%, respectively. And as 2025 draws to a close, now would be a good time to ask whether this Vanguard fund could match or top this year's showing in 2026.
First, although this ETF isn't a value fund in the traditional sense, it does offer value. By some estimates, international small-cap ETFs trade at 12 times forward earnings, compared with average ratios of 15 for large-cap equivalents and 27 for large-cap domestic stocks.
The even better news is that the Vanguard FTSE All-World ex-US Small-Cap ETF isn't home to a bunch of value traps. International small-caps, on average, are growing their earnings at faster paces than their larger peers.
Second, this small-cap ETF can add real diversification to U.S. investors' portfolios, and not just because it's an international fund. Diversification isn't just about gaining exposure to different asset classes or regions. It's also about ensuring portfolio components aren't heavily correlated to each other, and this ETF accomplishes that objective. International small-caps have a correlation of just 0.4 to the S&P 500 Growth index. That's something to consider for investors whose portfolios are heavily exposed to domestic technology stocks.
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Key Data Points
Another reason I'm bullish on the Vanguard FTSE All-World ex-US Small-Cap ETF is the overlooked status of smaller international companies. That's not to say the fund is small. With $9.7 billion in assets under management, it's not. Despite that heft, the fund remains off most investors' radar because international small-caps aren't widely tracked by Wall Street analysts, and funds that focus on them aren't commanding big inflows. However, perhaps that second point will start to change as more investors awaken to this ETF's story.
Geography matters
The Vanguard FTSE All-World ex-US Small-Cap ETF has something in common with many of its Vanguard stablemates: It has a massive portfolio -- 4,868 stocks, to be precise. And because it combines developed and emerging markets under one umbrella, more than 40 countries are represented in it.
The ETF assigns larger weights to the countries with the biggest equity market values. So, for example, Japanese companies make up the largest share of its weight: 14.5%. That's a good thing, too. As a note from Bank of America analyst Jared Woodard recently pointed out, the international small-cap ETFs that have been outperforming lately are the ones that are overweight Japanese stocks.
Some of those funds are also deriving solid gains from Australian and Israeli stocks, and those two countries combine to account for 6.6% of this fund's roster. Bottom line: The Vanguard FTSE All-World ex-US Small-Cap ETF has enviable fundamental traits and is worth putting on your watch list for 2026.