There May Be Value In The Emerging Markets – If You Know Where To Look

There May Be Value in the Emerging Markets – If You Know Where to Look by Christopher Gannatti, Associate Director of Research, The WisdomTree Blog

Over the past few years, it’s been somewhat unheard-of for the MSCI Emerging Markets Index to start a year outperforming the S&P 500 Index. But so far in 2015, that’s exactly what’s happening. The left-hand side of the chart below illustrates the point.

The Value of Dividends

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One way to look for “value” is to focus on stocks with relatively high dividend yields. And another way to access those companies is via an index comprised of high dividend yielders. In the emerging markets (EM) region, three indexes do this, albeit in different ways. And these differences make, well, all the difference. Let’s compare and contrast how index methodology can impact total return:

Evidence of Emerging Markets “Value” Gaining Steam

  • WisdomTree Emerging Markets Equity Income Index: This Index is the broadest of the bunch (395 members, as of March 31, 2015), and to qualify for initial inclusion, constituents must rank in the top 30% by dividend yield in a universe of all emerging market dividend-payers.1 Companies are weighted by cash dividends paid, leading to large exposures in Russian Energy stocks and Chinese Financials. These sectors happen to be rallying thus far in 2015, contributing to this Index outperforming the broader MSCI Emerging Markets benchmark.• S&P Emerging Markets Dividend Opportunities Index This Index is more narrow (100 members, as of March 31, 2015). A potential consequence of a lower number of constituents is a higher level of stock selection risk. There is also a much greater focus on stocks with higher yields, as well as optimizing the weight of the constituents to try to generate the highest possible yield, subject to certain constraints to ensure that adequate diversification is maintained. Larger exposures are to Brazil, China and Taiwan. Since Brazil and Taiwan have delivered lackluster performance, this Index is underperforming the broader MSCI Emerging Markets benchmark.• Dow Jones Emerging Markets Select Dividend Index This Index is also more narrow (100 members, as of March 31, 2015). This is another index where a lower number of constituents can potentially lead to a higher level of stock selection risk. Weighting is by indicated annual dividend yield, and there are capping rules in place to encourage adequate diversification. Larger exposures are to Taiwan, Brazil, China and South Africa. China is the only one of these more significant exposures to have delivered strong performance. This Index is underperforming the broader MSCI Emerging Markets benchmark.• What about the 16.90% Yield? Both the WisdomTree and S&P Indexes focus on dividend yield, landing them in the 6.0%?6.3% ballpark. From there to 16.9% is a large leap, and we’ll be looking to see whether it is maintained or is proven to be a signal for potential distress prior to companies cutting dividends. It’s difficult to view it as sustainable, but only time will tell.

Not All Indexes Are Created Equal

The MSCI Emerging Markets Value Index had 484 constituents as of March 31, 2014. As can be seen, the WisdomTree Emerging Markets Equity Income Index was the only Index that was even close to this number. The other Indexes, having approximately one-fourth the constituents, rely on stock selection to a much greater extent.

As value may be gaining momentum, what’s clear as of April 24, 2015, is that only one of the dividend-focused strategies is outperforming the broader MSCI Emerging Markets Index thus far in 2015.

1Refers to the WisdomTree Emerging Markets Dividend Index universe.

Important Risks Related to this Article

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 and intervention or political developments.

Dividends are not guaranteed and a company’s future ability to pay dividends may be limited. A company currently paying dividends may cease paying dividends at any time.