WisdomTree Middle East ETF Outperforms S&P 500, But Investor Beware

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 |  About: WisdomTree Middle East Dividend ETF (GULF), Includes: DES, DON, SPY, XLG
by: Richard Shaw

In our yield, valuation, volatility and return screen for superior equity ETF performance today, the WisdomTree Middle East ETF (NASDAQ:GULF), came out on top. It has an attractive looking yield in excess of 4% as well as outperforming the S&P 500 over the past 12 months. However, below the surface looking at it holding-by-holding, it does not look very good.

We used Fidelity data to screen for non-leveraged, non-inverse equity ETFs with at least three years of history (505 ETFs) that are in the better half for each of 3-year Sharpe Ratio (median value 0.79), 3-year total return (median value 14.60%), annualized yield (median value 1.80%), and price-to-cash flow (median value 8.20).

There were 37 ETFs that passed that screen.

We then filtered those 37 ETFs for those that have a 1-year Beta to the S&P 500 of less than 1.10, an annualized yield of 3% or more, and a 3-year Sharpe Ratio of 1.00 or more. There were 8 ETFs that passed that filter, shown in this table.

WISDOMTREE SMALLCAP DIVIDEND DES
WISDOMTREE MIDDLE EAST DIVIDEND FUND GULF
WISDOMTREE MIDCAP DIVIDEND DON
POWERSHARES HIGH YIELD EQUITY DIVIDEND ACHIEVERS PEY
GUGGENHEIM MULTI-ASSET INCOME ETF CVY
ISHARES DOW JONES SELECT DIVIDEND DVY
FIRST TRUST MORNINGSTAR DIVIDEND LEADERS FDL
WISDOMTREE EQUITY INCOME FUND DHS
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This table provides data from Fidelity for Beta, yield, P/CF, P/E, standard deviation and Sharpe Ratio for the 8 ETFs.

Of those 8, only 3 outperformed the S&P 500 based on dividend adjusted price charts from StockCharts.com:

  • DES
  • DON
  • GULF

These two relative performance charts compare dividend adjusted performance of the 8 ETFs vs. the S&P 500 ETF (NYSEARCA:SPY).

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Profiles (from Yahoo Finance) of the 3 ETFs that outperformed the S&P 500:

DES
The investment seeks to track the price and yield performance, before fees and expenses, of the WisdomTree SmallCap Dividend Index. The fund employs a passive management - or indexing - investment approach designed to track the performance of the WisdomTree SmallCap Dividend Index. It attempts to invest all, or substantially all, of its assets in the common stocks that make up the index. The index is a fundamentally weighted index measuring the performance of the small-capitalization segment of the U.S. dividend-paying market. The fund is non-diversified.

DON
The investment seeks to track the price and yield performance, before fees and expenses, of the WisdomTree MidCap Dividend Index. The fund employs a passive management - or indexing - investment approach designed to track the performance of the WisdomTree MidCap Dividend Index. It attempts to invest all or substantially all of its assets in the stocks that make up the index. It normally invests at least 95% of total assets in the component securities of the index. The index is a fundamentally weighted index that is comprised of the mid-capitalization segment of the U.S. dividend-paying market. The fund is non-diversified.

GULF
The investment seeks to track the price and yield performance, before fees and expenses, of the WisdomTree Middle East Dividend Index. The fund employs a passive management - or indexing - investment approach designed to track the performance of the index. It attempts to invest all, or substantially all, of its assets in the common stocks that make up the index. The fund normally invests at least 95% of its total assets in the component securities of the index. The index is a fundamentally weighted index that is comprised of companies in the Middle East region that pay regular cash dividends on shares of common stock. The fund is non-diversified.

Comment On The Indexes

All three ETFs are from WisdomTree and are based on their fundamental dividend weighted indexes. Presumably, that tends toward higher quality companies. That may well be the case for DES and DON, although we have not at this point analyzed the individual constituents of each index.

With regard to GULF, however, we have analyzed the individual holdings and are not comfortable with a quality assumption.

GULF has 50 holdings from 7 Middle East countries:

  • 37.66% UAE
  • 27.85% Qatar
  • 16.60% Kuwait
  • 7.79% Morocco
  • 5.96% Eqypt
  • 3.14% Oman
  • 1.07% Jordan

There are higher risks in these frontier stock markets than in the US, and it is less reasonable to make assumptions about the quality of the dividend stocks there. Accordingly, we used the Wright Investor's Service quality rating system (covers more than 30,000 stocks in the ThomsonReuters Worldscope database) to evaluate the quality of the GULF holdings.

The Wright rating system is described at the end of this post. The data and chart that follow were obtained at CorporateInformation.com

To get a feel for the relative quality of the GULF holdings versus a US large-cap standard, we analyzed the 50 stocks in the Russell Top 50 US stocks (proxy XLG) using the Wright system, and converted their letter and number ratings to a 100 point scale, and then set the quality level of the Russell index at 100. We then rated GULF holdings in the same way to determine the quality relative to the Russell Top 50.

The quality rating of each holding of each ETF was weighted by the weight of the stock within the ETF.

Here is how GULF stacked up relative to XLG.

GULF on an overall basis has 76% of the quality of the Russell Top 50, somewhat higher ratings for individual dimensions of liquidity, financial strength and profitability, but only about 1/2 of the overall growth rate.

Of the 50 stocks in the WisdomTree Middle East index only 7 have (1) average or better liquidity, (2) investment grade financial strength and profitability, and (3) at least a moderate overall growth rate.

In the Wright rating method, investment grade would require an A or B rating (on the A, B, C, D scale) and a growth rating of at least 4 (on their 20 point scale). Those stocks are:

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The other 43 are significantly lacking in one or more of those categories, and some of them are very low quality, such as these (where "L" means limited and "N" means insufficient data).

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Among the best rated stocks, not all are particularly attractive as dividend stocks.

These charts from CorporateInformation.com for the best 7 holdings show the price, earnings and dividends for 5 years.

While we like companies with a significant management stake, we are a little uncomfortable with foreign companies in emerging or frontier markets where insiders own a huge controlling stake in the company. Insider control is very common in developing markets. Insider control in combination with underdeveloped investor protections and uncertain auditing substantially increases risks.

Here is a table of yield, payout ratio and insider percent holdings for the 7 quality constituents of the 50 stock WisdomTree Middle East index. The 2 of 7 with more than 50% would give us particular pause. The 40+% stakes would all create effective management control.

You might well want to invest in the Middle East, and GULF may be a best available alternative for that, but in addition to the obvious geopolitical risks of the region, and the investment operations risk of investing in frontier markets, be aware that if you looked at the individual holdings you would be very unlikely to want to own the vast majority of them.

If you would not want to own the constituents, you might not want to own the index.

Know what you own and know why you own it. Be careful.

WRIGHT QUALITY RATING:

The Wright Quality Rating, measures the overall investment quality of a company.

Wright Quality Ratings are based on numerous individual measures of quality, grouped into four principal components:

  1. Investment Acceptance (i.e. stock liquidity),
  2. Financial Strength,
  3. Profitability & Stability, and
  4. Growth.

The ratings are based on established principles using 5-6 years of corporate record and other investment data.

The ratings consist of three letters and a number. Each letter reflects a composite qualitative measurement of numerous individual standards which may be summarized as follows:

  • A = Outstanding;
  • B = Excellent;
  • C = Good;
  • D = Fair;
  • L = Limited;
  • N = Not Rated.

The number component of the Quality Rating is also a composite measurement of the annual corporate growth, based on earnings and modified by growth rates of equity, dividends and sales per common share. The Growth rating may vary from 0 (lowest) to 20 (highest). The highest quality rating assigned by Wright is AAA20.

Disclosure: QVM has positions in SPY as of the creation date of this article (June 7, 2013). We certify that except as cited herein, this is our work product. We received no compensation or other inducement from any party to produce this article, and are not compensated by Seeking Alpha in any way relating to this article.

General Disclaimer: This article provides opinions and information, but does not contain recommendations or personal investment advice to any specific person for any particular purpose. Do your own research or obtain suitable personal advice. You are responsible for your own investment decisions. This article is presented subject to our full disclaimer found on the QVM site available here.