Why We're Bullish On Emerging Market Equities

Includes: DEM, EEM, VWO
by: WisdomTree

Co-authored by Christopher Gannatti, Research Analyst at WisdomTree

The markets have certainly been volatile in early 2012, and the emerging markets represent perhaps the most volatile of the various segments of the equity markets.

While there is little question that Emerging Markets are expected to outpace Developed Markets in terms of economic growth over the coming years, this alone does not necessarily portend positive performance for emerging market (EM) equities[1]. I believe the overall attractiveness of a region's economic growth potential must not be viewed in isolation, and that it is important to employ an additional focus on the valuation[2] of the region's equity markets.

With over 90% of the EM companies paying a dividend over the prior 12-months[3], we believe the trailing 12-month dividend yield[4] serves as an important valuation indicator for EM equities. To test this conclusion, we conducted a study to see how EM Equities performed during subsequent 1-year periods after various trailing 12-month dividend yields. The results showed that the starting trailing 12-month dividend yield had a significant relationship with the following calendar year's returns. We recognize that throughout the statistics that follow we are utilizing index-level data. Investors cannot invest directly in indexes, and indexes do not account for potential costs, fees or expenses that may adversely affect returns.

· As of April 30, 2012, the trailing 12-month dividend yield of EM equities was 2.93%[5].

· Compared to the 23 year end data points[6] available, a value of 2.93% would rank as the 4th highest dividend yield[7].

· High dividend yields correspond to relatively low prices and low valuation points for these markets. The analysis indicates that, when year-end trailing 12-month dividend yields of EM equities were at these higher relative levels, the following calendar year's returns, on average, were stronger than they were in calendar years following lower year-end relative trailing 12-month dividend yields.

Our full research piece outlining the performance of EM equities, including an appendix with the data for all 23 years, is available here.

Within the piece, the primary analysis was structured as follows:

· We broke the 23 full calendar years of index data into two buckets. Specifically, the positioning of various years into these buckets was based on their trailing 12-month dividend yield values as of 12/31 of each respective calendar year.

· "High Dividend Yield Years": This bucket was determined for years in which the starting trailing 12-month dividend yield was above the median[8] of 2.24%.

· "Low Dividend Yield Years": Years when the starting trailing 12-month dividend yield was below the median of 2.24%.

· For comparative purposes, we also measured the average of "All Calendar Years" to serve as a baseline figure from which to measure to relative performance difference between the High and Low Dividend Yield Years.

Figure 1: Performance Summary of the EM Equities for Following Calendar Year After High and Low Trailing 12-Month Dividend Yields

Figure 1 indicates the average calendar year performance for 1-year periods following the observed dividend yields[9] within the respective buckets as defined earlier in this piece.

· The average performance of EM Equities during years following "High Dividend Yield" values was 34.58%, over 34 full percentage points greater than the return associated with years following when EM Equities were characterized as having a "Low Dividend Yield."

· The calendar years following high trailing 12-month dividend yields had performance that averaged over 17 percentage points better than the average performance of all 23 calendar years. The calendar years following low trailing 12-month dividend yields had performance that averaged about 17 percentage points worse than the average performance of all 23 calendar years.

· Four of the five best single calendar year return periods for EM equities came during years that followed trailing 12-month dividend yields that ranked among the five highest of those for all 23 calendar years.

· On the other hand, the lowest observed year-end trailing 12-month dividend yield for EM equities was observed on December 31, 1999, and it was followed up by the 2nd worst subsequent calendar year return during the year 2000 of all 23 years studied, specifically -30.61%

Ultimately, we view this analysis as a valuable illustration of the point that trailing 12-month dividend yields matter for EM equities. However, past performance is not indicative of future results and this analysis merely indicates a relationship that has occurred over past periods. There is no guarantee that it will occur similarly over future periods.

In conclusion, we believe the current dividend yield classifies as one of the "High Dividend Yield." Periods such as these were historically associated with average performance results significantly better than those witnessed during the "average[10]" year. To those interested in emerging markets, the historical evidence makes us extra bullish about the potential prospects for EM equities.

Index Definitions

MSCI Emerging Markets Index: A free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.

Unless otherwise stated, data source is WisdomTree.

There are risks associated with investing, including possible loss of principal. Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty. Funds focusing on a single sector generally experience greater price volatility. Investments in emerging, offshore or frontier markets are generally less liquid and less efficient than investments in developed markets and are subject to additional risks, such as risks of adverse governmental regulation, intervention and political developments.

WisdomTree Funds are distributed by ALPS Distributors, Inc.

Jeremy Schwartz and Chris Gannatti are registered representatives of ALPS Distributors, Inc..

WIS004174 5/2013

[1] Emerging Market equities: Throughout this piece emerging market equities specifically refer to the MSCI Emerging Markets Index, an index meant to be a comprehensive measure of the performance of emerging market equities across 21 emerging markets. It is important to note that, though broad, this index does not measure the performance of every publicly-traded emerging market equity security.

[2] Valuation: Using different factors, such as earnings or dividends, valuation analysis looks to measure whether one asset or index looks relatively cheap/expensive versus another.

[3] EM companies refer to the constituents of the MSCI Emerging Markets Index. The 90% figure is sourced from Bloomberg, as of 3/31/2012.

[4] Trailing 12-Month Dividend Yield: The sum of the prior 12 months worth of dividend payments divided by the current share price. Higher values indicate that more dividends have been generated over the prior year per dollar of current share price, a potential benefit for those who believe dividends are a major component of equity returns.

[5] MSCI

[6] 23 Year End data points: The MSCI Emerging Markets Index has data back to 12/31/1987, and as such, through 12/31/2010, 23 values were available for which there would be a subsequent full calendar year of equity performance to measure.

[7] MSCI

[8] Median: A point within a list of data for which 50% of values lie above and 50% of observations lie below. With the 23 values, the 12th -ranked value would be the median, with 11 above and 11 below.

[9] This is an average of 1-year periods taken individually, not an average annual, compounded return.

[10] Average in this case refers to the average calendar year return of EM equities, shown in the chart as 17.42%.

Disclosure: I am long DEM.