In the current risk-off environment, many investors are lowering their exposure to emerging markets. But while these stocks have underperformed during the recent sell-off, I believe longer-term fundamental arguments for emerging market equities still hold.
One asset class that can potentially help investors take advantage of the longer-term opportunity in emerging markets while lessening near-term exposure to volatile market segments is high-dividend emerging market funds. Here are three reasons why investors should consider these funds.
Lower Beta: Since the sell-off began, an index of emerging market high dividend payers is down around 12.5%, while a broader emerging market equity index is down more than 16%. This is consistent with historical patterns as high dividend payers in both emerging and developed markets generally have been less volatile than the broader market.
In fact, high dividend payers in emerging markets have a beta (a measure of the tendency of securities to move with the market at large) of only around 0.8 to the broader emerging market index. In other words, high dividend payers in emerging markets generally move around 0.8% for every 1% change in the overall emerging market universe. In a volatile market environment, this lower beta can help cushion the downside.
So why do high dividend payers have a lower beta? They tend to be more mature, established firms concentrated in less volatile industries. For example, the Dow Jones Emerging Markets Select Dividend Index has a heavy weighting to telecommunications and electric utilities, traditionally low beta sectors that tend to be less volatile than the broader market. In contrast, the largest industry in the broader MSCI Emerging Markets Index is financials, one of the most volatile sectors in recent years.
High Yield: The yield on emerging market dividend payers is high compared to that of many developed markets. For instance, the Dow Jones Emerging Markets Select Dividend Index offers a yield of more than 6%, while the United States’ S&P 500 index yields only about 2.5%. The 6% yield figure also compares favorably with traditional high yielding countries like the United Kingdom, Hong Kong and Australia.
Valuations: Finally, high dividend payers in emerging markets generally trade at a significant discount to most global equity benchmarks. In fact, these stocks are currently trading at less than 10x earnings, a 20% discount to developed markets and cheaper than broader emerging market equity indices.
In short, emerging market high dividend funds offer an attractive balance between income and risk management at a nice valuation. Investors can access this opportunity through the iShares Emerging Markets Dividend Index Fund (NYSEARCA: DVYE).