iShares Emerging Markets Dividend ETF (NYSEARCA:DVYE) is an exchange-traded fund providing "exposure to a broad range of established companies in emerging markets countries", most notably Brazil (25%), China (25%), and Taiwan (9%).
Assets under management were "only" $679 million as of April 29, 2022, according to iShares. This follows mostly positive inflows over the past year, albeit including some significant outflows of $58 million in the week from March 7, 2022.
The fund is diversified with the largest holding only representing about 2% of the fund. In terms of sector exposures, DVYE is more heavily tilted toward Materials (18%), Real Estate (18%), Financials (12%), and Utilities (12%).
Technology (5%) and Consumer Discretionary (5%), for example, are small exposures. This makes the sector make-up of DVYE quite different from major Western funds that tend to have larger allocations to these kinds of sectors. Morningstar presents the breakdown as follows:
So, DVYE is more of a "Cyclical" fund, with some degree of Sensitive and Defensive exposures too. You would imagine DVYE performing well in the beginning and middle phases of the business cycle in this regard. Fidelity research on this would suggest that, as of 2022 Q1, Brazil is probably mid-stage, and China is probably in recession. Those two countries being the top two geographic exposures, you could argue DVYE is somewhat hedged against the business cycle.
Still, if most of the world is in the mid- to late-stage of the current business cycle, DVYE is probably on the whole more exposed to flat-lining. Equity markets tend to lead the economy (i.e., you can't invest after the fact), and indeed DVYE has already sold off into the lows of 2020.
The U.S. dollar index has also risen by about 8% year-to-date, and a stronger U.S. dollar does tend to punish international risk assets, especially assets denominated in foreign currencies (like DVYE's underlying holdings), since they become less valuable in USD terms.
Still, on a 30-day SEC yield basis, DVYE's yield is approximately 9.38% (as of March 31, 2022) and 8.48% on a twelve-month trailing basis (according to iShares themselves). The fund has not performed well over time though. Since inception, the annual total return even accounting for distributions is 0.11% per annum according to iShares, so essentially zero, or negative in real terms (after you account for inflation). On the other hand, DVYE has sold off significantly recently, so it is worth reviewing the valuation.
Morningstar estimates a modest 8.81% annual average earnings growth rate over the next three to five years for DVYE's portfolio. I can use this to gauge earnings on a base that we can derive from the fund's benchmark index's most recent factsheet. As of April 29, 2022, the trailing and forward price/earnings ratios were 3.65x and 3.87x, respectively, with a price/book ratio of just 0.7x. The forward return on equity was therefore 18%, which is good, and the indicative dividend yield was thought to be 12.92%. It still seems as though the market is pricing in all of the "equity risk premium" into the dividend yield, but the historically weak price performance of DVYE is interesting and would suggest almost liquidation, so it is worth assessing whether the actual price of DVYE shares is due for an "upward correction".
Before beginning a valuation with the above data, we need to get an idea for a fair cost of equity for the fund. I use World Government Bonds for government bond yield data and Professor Damodaran for equity and country risk premium data.
The country-weighted cost of equity per my calculations is 13.63%, which includes a relatively high weighted risk-free rate of 6.63% (much higher than the yields on offer in the developed western world, such as the United States, which are close to zero).
Even with an implied dip in one-year forward earnings (based on the index provider S&P Dow Jones Indices' projections), if we continue with an average three- to five-year earnings growth rate of about 8.48% as a target (my calculations' five-year average is a more modest 4.3%, including the forward one-year dip), DVYE is most likely undervalued.
Given the level of uncertainty as to emerging markets stocks and their earnings, I am going to instead assume zero earnings growth after the first year of negative earnings growth. And 0% "to perpetuity" in this case. Holding our cost of equity constant at 13.63%, our valuation still indicates a potential uplift of 89.6%. The implied cost of equity is, therefore, higher, in this case, 25.84%, which is exceptionally high. It seems as if risk sentiment is very negative on emerging markets stocks, even if dividend payouts are high, and this is probably driven by a combination of political uncertainty and significant 2022 FX deviations with the U.S. dollar spiking.
Nevertheless, assuming zero earnings growth, implied returns are still very high, and therefore, it seems near impossible to lose money owning DVYE at current prices. The dividend yield is high, and arguably, the U.S. dollar is close to fair value on a fundamental basis now, even if the recent surge upward was more likely to be driven by an unwind of FX carry trades on the back of a much stronger international yield differential (in favor of USD). The Economist's Big Mac Index thinks USD is probably slightly undervalued as of January 2022, but otherwise close to fair value (versus EUR; the largest component of the U.S. dollar index).
On the other hand, The Economist thinks that the Japanese yen, another significant component of the U.S. dollar index (albeit just 13.6% as compared to the euro's weight of 57.6%) is undervalued versus USD by 30.4%. When FX markets stabilize, it is possible we will see a much stronger Japanese yen, which could help pull the dollar down on a broader basis, even if the euro holds mostly firm. A more stable and/or softer USD should be bullish for risk assets including emerging markets stocks.
I should also note The Economist's crude model also suggests the Brazilian real is 22.9% overvalued, and the Chinese yuan is 4.8% overvalued (both against USD). So, it is possible that FX market normalization could be economically neutral for DVYE shareholders. Yet a softer dollar should generally buoy risk assets, even if DVYE's largest FX exposures are not favorable. A stronger U.S. dollar supports unwinding of carry trades and engenders negative risk sentiment, so the opposite is usually going to be favorable.
Also, while Brazil's current account is still negative (and therefore the risk of some depreciation is present), the Chinese current account is positive, and so arguably the Chinese yuan still deserves to be stronger. And if China's next phase is to begin a new business cycle, emerging markets such as those that DVYE invests in could perform well on a cyclical rebound.
Given the number of geographical exposures and variables to consider, DVYE looks risky and difficult to predict. And risk sentiment is not strong even if inflows have been positive over the past year; DVYE is not a widely popular fund, and the valuation would imply very high equity risk premiums embedded. I think that given the level of uncertainty that investors are placing on DVYE, the ETF presents a very viable macro-oriented value investment opportunity.