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Great Time for Dividend Investors: Consider Emerging Markets & Dividend ETFs

|Includes:DGS, ECH, ECON, VanEck Vectors Indonesia Index ETF (IDX)

The importance of dividends is often overlooked.  Investors tend to focus on price appreciation in bull markets.  Watching a stock go from $25 a share to $60 is more exciting that watching a stock sit at $25 for several years while you collect and reinvest a 3% dividend.  That’s too boring for many investors.  But the steady growth of dividends plays a very important role in making your money grow over time.

The past decade is a great example of how dividends have helped improve the returns of a stock market that has otherwise been pretty disappointing.  For the 10 years ending Sept. 23, 2011 the S&P 500 Index:

  • 1.3% average annualized return excluding reinvested dividends
  • 3.6% average annualized return including reinvested dividends
  • Receiving dividends & reinvesting them added 2.3 percentage points per year to an investor’s return compared to the return generated by price appreciation alone of the underlying stocks in the S&P 500

Sources:  Morningstar, Yahoo! Finance

In today’s low return environment, earning an extra 2.3% of return per year is attractive. 

Dividends accounted for 33% of the total return of the S&P 500 Index over the past 80 years, according to Standard & Poor’s.  Plus:

  • Dividends allow investors to capture the upside while providing some downside protection in volatile down markets.
  • Dividend-paying stocks can also enhance current income, especially with bond yields as low as they are now.

Every investor needs to determine how dividends fit into their investment strategy.  Dividends can provide growth, income or stability to your portfolio – or some combination of all three options.

In addition to the traditional approach of investing in solid dividend stocks, consider dividend ETFs (exchange-traded funds) which have grown dramatically in popularity over the past 2 years.  Morningstar is an excellent source for identifying the dividend ETF that best fits your investment strategy

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The rise of the emerging market consumer is the single greatest macro trend of the next 25 years.  
Capitalism is working in the developing world.  The key is to focus on emerging markets with growing urban middle classes who will fuel consumer demand.  As incomes continue to rise, so should the profits of companies that target this new middle class.  Slow growth in the West will continue to be drag on those emerging markets that rely heavily on exports.  Western investors have been burned in emerging markets again and again, so you have to accept periods of volatility.

Investor interest in emerging markets will continue, as growth in the U.S. and Europe remains weak. Every mega city in the world except Tokyo is in a country that’s classified as an emerging market. Again: The rise of the new urban middle class in the developing world is the single biggest macro trend for the next 25 years.

I believe the best way to get exposure to this trend is via emerging market ETFs

It might sound crazy to be looking at emerging market exchange-traded funds (ETFs) right now.  Emerging markets have been hard hit by inflation in 2011.  Major players like Brazil and China have been unable to effectively curtail inflation.  But emerging market ETFs were experiencing problems before global investors started worrying about a double-dip recession, before America’s credit rating took a hit and before the debt ceiling debate.

Why would investors consider emerging market ETFs now?  There’s an old axiom: “When there’s blood in the streets, buy.”  That’s fine if you’re a die-hard speculator.  My view is that the question for investors’ should be:  When the market gets its act together, where do I go for emerging market growth without the drawbacks of inflation?

Below we have 4 emerging market ETFs with the most compelling mix of controlled inflation and the potential to bounce back and outperform comparable emerging markets.  Put them on your watch list.

  • EG Shares Emerging Markets Consumer (NYSEARCA:ECON) – This is the most popular emerging markets consumer ETF, consisting of about 30 stocks of consumer goods & services in emerging markets.  The largest country allocations are Brazil, South Africa and Mexico but also in India, Chile, Malaysia, China, Russia and Colombia.  While ECON is focused exclusively on the consumer sector, there is a fair amount of diversification within this segment of the market. The portfolio includes both consumer discretionary and consumer staples companies from various sub-sectors, including auto manufacturers, food producers, media stocks and travel and leisure companies.
  • WisdomTree Emerging Markets SmallCap Dividends (NYSEARCA:DGS) – Now is a great time to be a dividend investor.  Dividend ETFs in emerging markets can be a great way to tap into emerging market growth.  There is no shortage of ETFs offering dividend yields.  OK, most emerging markets and small-caps aren’t working right now.  In fact, DGS’ chart is ugly.  Nevertheless, DGS has the potential to be a strong performer as it has been in the past.  It just needs a better market environment to justify a buy recommendation.  DGS is unique in its focus small cap equities in Taiwan, South Korea, South Africa, Thailand, and other developing economies.  It’s concentrated in 5 sectors: financials, industrials, consumer discretionary, IT and materials.  Remember though: DGS’ emerging markets/small cap combination make is very speculative!
  • iShares Chile Investable Market Index (NYSEARCA:ECH) – Chile has been remarkably responsible in managing the windfall it’s received from high copper prices.  Inflation has slowed in Chile as it has made far better inflation-fighting progress than Brazil.  The ECH fund is a bit more diversified across sectors than many other country funds.  Many Chilean companies pay generous dividends, but that has yet to be captured by this ETF.  For the last 12 months, the yield has been only 1.5%.
  • Market Vectors Indonesia (NYSEARCA:IDX) – IDX had been of the best-performing emerging markets ETFs before global equity markets dropped at the end of July and this fund has been particularly volatile.  But its extreme volatility is exactly the reason investors should put this fund on their watch list to see if it will revert to its longer-term higher trend or if this is the beginning of a new downward slide for Indonesia.  Indonesia has done a better job than most to tackle inflation.  If their inflation-fighting policies continue to succeed, the IDX could be a strong ‘buy-on-the-dip’ candidate once the market’s volatility clears.


Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.