Are emerging market dividend ETFs the answer in times of low yield?

Jul 22nd, 2016 | By | Category: Equities

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With bond yields at record lows – the 10-year gilt yield is down to 0.8% today from 3% in January 2014 investors have been pushed towards alternative strategies for income, including European-domiciled emerging market dividend exchange-traded funds. The sector has yielded between 4% and 6% annually compared to 2% from developed market counterparts over the past three years, according to a new study from Morningstar.

SSgA launches new emerging markets and global equity SPDR ETFs

Emerging market dividends could be the answer to the low yield problem

Despite a relatively higher yield, this equity sector’s performance has not beaten the overall market – it has tanked compared to global equities over three years. Emerging market dividends fell 14.7% in USD on an annualised basis to the end of May, while the global benchmark grew by just over 19% in the same period.

Therefore if investors want to include emerging market equities, they might be more tempted to place their capital specifically with emerging market dividend funds, where the relatively higher yield helps to compensate for the falling return of the underlying stocks.

Dividends are distributed among shareholders in the form of cash or shares, and can provide investors with a regular income. For a dividend-focused ETF, the ETF manager will collect all the company dividends and either distribute them as cash to investors or reinvest the cash in the underlying securities.

Besides yield and return, investors should note the defensive sector bias within these dividend-oriented emerging market ETFs and the emphasis on exporting-focused countries like Brazil, South Africa and Russia which have been hit by falling oil prices. It is also a relatively new ETF sector, so underlying indexes will not be able to screen stocks’ earning or dividend growth over longer than around three years.

The Morningstar research focuses on the three emerging market dividend ETFs available in Europe: the iShares Emerging Markets Dividend UCITS ETF (LSE: IEDY), the SPDR S&P Emerging Markets Dividend UCITS ETF (LSE: EDVD) and the WisdomTree Emerging Markets Equity Income UCITS ETF (LSE: DEMD). All tickers are listed in London in USD, but the three funds are also listed on the exchange in sterling.

(The study excludes two more niche funds on the European market – a small-cap emerging market dividend fund from WisdomTree, and the new PowerShares FTSE Emerging Markets High Dividend Low Volatility UCITS ETF.)

In terms of annual costs, the cheapest of the three funds is WisdomTree at 0.46%. It is also the newest ETF, having launched in 2014, and has only grown to around $34 million in assets. There are 400 underlying stocks in the index – four times the number of the other two ETFs – although it is still quite concentrated with the top 10 holdings representing over a quarter of the fund.

The iShares fund only has 100 stocks in the underlying DJ EM Select Dividend Index, but is the least concentrated within the top 10 assets at just 19% of the fund. It is the most expensive, however, at 0.65%, but also holds the most assets by far at more than $188 million.

Lastly, SPDR’s EDVD launched in 2011, the same year as iShares, but has only grown to just over $90 million in assets in that time. It is also by far the most concentrated fund, almost a third – 31% – of its weight in the top 10 holdings. EDVD is the worst performer over the last year; it has fallen 10.6% in USD terms, according to JustETF.com.

The good news is that emerging markets have started to rebound – the MSCI Emerging Markets Index is up 4% in June – as the US Federal Reserve has left interest rates unchanged for four monetary policy meetings in a row and commodity prices have stabilised. Dividend funds also put less weight in China and focus more on the rising consumer sector than its market cap-weighted MSCI parent index, the study pointed out.

Morningstar concluded it is “too early” to forecast the outlook for the sector, despite currency markets and commodity prices stabilising. It is clear that the dividend-focused sector has underperformed overall cap-weighted emerging markets in the last three years, yet Morningstar urges ETF investors to not completely ignore this asset class.

“But in all fairness, these strategies may have been launched during their worst possible days, and, by discarding them completely, we may be committing a serious case of time-period bias,” the report reads.

Despite this, dividend funds’ performance has diverged massively from the MSCI World Index over these three years. While emerging market dividends fell 14.7% in dollar-terms on an annualised basis to the end of May, the global benchmark grew by just over 19% in the same period.

Besides yield and returns, investors should note the defensive sector bias within these dividend-oriented ETFs and the emphasis on exporting-focused countries like Brazil, South Africa and Russia which have been hit by falling oil prices. It is also a relatively new ETF sector, so underlying indexes will not be able to screen stocks’ earning or dividend growth over longer than around three years.

Yet the falling returns of emerging market equities increases the relative value of a dividend yield, therefore emerging market dividend ETFs may still present a tempting investment, the study argues.

Emerging markets have also started to rebound – the MSCI Emerging Markets Index is up 4% in June – as the US Federal Reserve left interest rates unchanged for four meetings in a row meaning commodity prices have stabilised. Dividend funds also weight less in China and focus more on the rising consumer sector than its market cap-weighted MSCI parent index, the study pointed out.

The research focuses on the three emerging market dividend ETFs available in Europe: the iShares Emerging Markets Dividend UCITS ETF (IEDY), the SPDR S&P Emerging Markets Dividend UCITS ETF (EDVD) and the WisdomTree Emerging Markets Equity Income UCITS ETF (DEMD). All tickers are listed in London in USD, but the three funds are also listed on the exchange in sterling.

(The study excludes two more niche funds on the European market – a small-cap emerging market dividend fund from WisdomTree, and the new PowerShares FTSE Emerging Markets High Dividend Low Volatility UCITS ETF.)

In terms of annual costs, the cheapest of the three funds is WisdomTree at 0.46%. It is also the newest ETF, having launched in 2014, and has only grown to around $34 million in assets. There are 400 underlying stocks in the index – four times the number of the other two ETFs – although it is still quite concentrated with the top 10 holdings representing over a quarter of the fund.

The iShares fund only has 100 stocks in the underlying DJ EM Select Dividend Index, but is the least concentrated within the top 10 assets at just 19% of the fund. It is the most expensive, however, at 0.65%, but also holds the most assets by far at more than $188 million.

Lastly, SPDR’s EDVD launched in 2011, the same year as iShares, but has only grown to just over $90 million in assets in that time. It is also by far the most concentrated fund, almost a third – 31% – of its weight in the top 10 holdings. EDVD is the worst performer over the last year; it has fallen 10.6% in USD terms, according to JustETF.com.

Morningstar concluded it is “too early” to forecast the outlook for the sector, despite currency markets and commodity prices stabilising. It is clear that the dividend-focused sector has underperformed overall cap-weighted emerging markets in the last three years, yet Morningstar urges ETF investors to not completely ignore this asset class.

“But in all fairness, these strategies may have been launched during their worst possible days, and, by discarding them completely, we may be committing a serious case of time-period bias,” the report reads.

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