Don’t Turn To Emerging Markets For Higher Dividend Yields

Investors who put their money into emerging markets back at the beginning of this decade have been rewarded with…well, pretty much nothing! An investment in the iShares MSCI Emerging Markets ETF (NYSE:EEM) at the beginning of 2010 would have produced a total return of -2.3%.

During that same time frame, the S&P 500 has returned more than 116%.

But the tides may be beginning to turn. Emerging markets are up 15% in 2016, while dividend paying emerging markets equities are performing even better. Investors reaching into equities for higher yields are pushing the valuations in traditionally conservative areas like utilities and consumer goods to very rich levels making them less attractive on a relative basis. Long-term bonds look even worse following a decades-long bull market and the Fed poised to begin lifting rates as early as September.

One play for income that investors may find enticing right now is the WisdomTree Emerging Markets High Dividend ETF (NYSE:DEM). The fund starts with the WisdomTree Emerging Markets Dividend Index and ranks them according to dividend yield. Stocks that fall in the top 30% of this ranking make it into the portfolio. The fund currently pays a dividend yield of 4.2%.

Investors may like the combination of high yield and strong recent performance but it’s important to look at how the fund has gotten where it’s at right now. Emerging markets do well when the rest of the world does well since they rely so much on foreign investment and commerce. Emerging markets rallied hard following the financial crisis as the Fed dropped interest rates and came closer to launching multiple rounds of QE but the rally stalled as the Fed began running out of ammunition and the domestic economic recovery remained tepid. Emerging markets stocks slumped in 2015 on concerns over a tightening monetary policy and have, conversely, rallied as it became clearer that the Fed planned a more deliberate pace of rate hikes.

With the Fed getting set to raise rates again soon (the Fed futures market suggests a roughly 50-50 chance of a rate hike by the end of the year), it’s tough to get excited about the prospects for emerging markets in an environment of tighter monetary policy. While the 4% dividend is enticing, it’s definitely not meant to be a core dividend holding. The quarterly dividend fluctuates greatly (recently, it’s been as high as $1.26 but paid no dividend at all in Q1 2016).

Years of flat performance make the fundamentals fairly compelling with a P/E ratio of 12 and trading near book value overall. 2016’s performance may lead some to believe that emerging markets are back but the headwinds that have limited its potential in recent years still appear to be in place – lack of further economic stimulus. In addition, top country holdings such as China, Brazil and Russia all face their own significant economic issues.

Emerging markets deserve a small allocation in a broader portfolio due to their diversification benefits and high growth potential. In this case, however, it’s wise to not be seduced by recent performance and the temptation to go all in.

About the Author: David Dierking
Headshot of David DierkingDavid Dierking is a freelance writer focusing primarily on ETFs, mutual funds, dividend income strategies and retirement planning. He has spent more than 20 years in the financial services industry and his background includes experience in investment management, portfolio analytics and asset/liability management at both BMO Financial Group and Strong Capital Management.

He has written for Seeking Alpha, Motley Fool, ETF Trends and Investopedia and was also included in the panel for ETFReference.com’s “101 ETF Investing Tips from the Experts”. He has a B.A. in Finance from Michigan State University and lives in Wisconsin with his wife and two daughters.

You can connect with David on Twitter and LinkedIn.

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