How Real Is The Need For Emerging Market Dividend ETFs?

by: Gary Gordon

In the last few days, investors have been willing to take on a bit more cyclical growth risk. Specifically, they’ve pushed up the prices on technology and materials stocks, and pushed down the prices of dividend stalwarts from Verizon (NYSE:VZ) to Altria (NYSE:MO).

Even so, you would be hard pressed to find many who are ready to give up on the relative safety of income producing assets. The love affair with treasury bonds won’t go away simply because bond bears say, “See, the 10-year is up from 1.4% to 1.6%. The treasury trade is unwinding!”

In reality, the intermediate- and long-term trends both still favor dividend producers. What may be less certain is whether or not the same dynamic is beginning to make its way into emerging market equities.

At the present time, there are roughly five emerging market dividend vehicles with sufficient dollar volume. With the exception of WisdomTree High Yield Equity Income (NYSEARCA:DEM), however, few have been around for an extensive period. What’s more, there’s a rather dramatic difference in the performance of the various products.

Emerging Market Dividend ETFs: Less Commodity-Oriented, More Income-Oriented
WisdomTree Asia Pacific Ex Japan (NYSEARCA:AXJL) 11.0%
WisdomTree Emerging Market Small Cap Dividend (NYSEARCA:DGS) 7.6%
WisdomTree Emerging Market High Equity Income (DEM) 4.1%
SPDR S&P Emerging Market Dividend (NYSEARCA:EDIV) -6.3%
EG Shares Low Volatility Emerging Market Dividend (NYSEARCA:HILO) 4.2%
Vanguard Emerging Markets (NYSEARCA:VWO) 7.6%
SPDR S&P Emerging Market Small Cap (NYSEARCA:EWX) 14.1%

Neither the large-cap dividend emergers nor the lone small-cap dividend emerger has performed as well as the broader emerging market benchmarks in 2012. This may come as a surprise when one considers how well Vanguard High Dividend Yield (NYSEARCA:VYM) and iShares High Dividend Equity (NYSEARCA:HDV) have done in comparison to SPDR S&P 500 (NYSEARCA:SPY). Until very recently, VYM and HDV were outperforming SPY. (Note: As of 8/7/12, SPY has an 11% edge over VYM and HDV’s approximate gains of 10%.)

Most analysts acknowledge that over any length of time - short-, medium- or long-term - emerging market corporations will grow both their earnings and their dividends at a faster pace than developed world companies. And yet, emerging market dividend funds are not currently competitive with U.S. dividend funds nor the broader emerging market benchmarks.

So what should one think about the underachievement in the emerging market dividend space? Is it merely a matter of patience? Or are these ETFs tracking unreliable indices with questionable risk-reward benefits?

Conceptually, I like ”EM Div” ETFs. Yet one reason that they may not be as attractive as their domestic counterparts are the comparable yields. The annualized dividend yield in this space is not significantly higher than emerging market sovereign debt. That fact may contribute to the enormous interest in PowerShares Emerging Market Sovereign (NYSEARCA:PCY). In contrast, most of the popular U.S. Dividend ETFs have yields that are close to 2x the 1.6%-yielding 10-year treasury.

Granted, for many folks, Vanguard Emerging Markets (VWO) may not be worthy of the volatility here in 2012; not everyone is going to jump through hoops for 2.2% annualized. Nevertheless, there are emerging market investments with better-than-average dividend production and less volatility than VWO or SPY. For example, iShares MSCI Malaysia (NYSEARCA:EWM) has a beta of .79 and an annual dividend yield of 3.7%.

Long-time readers know that I discuss Malaysia (EWM) with a great deal of frequency. Not only is the dividend more attractive than the broader emerging market benchmark, but the EWM:VWO price ratio demonstrates significant relative strength. If you’re going to select an emerging market investment ... if you’re going to look for yield to offset the risk of ownership ... EWM is tough to beat.

Click to enlarge

EWM VWO Price Ratio

Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.