Dividend Investors: Have You Considered Emerging Market ETFs?

Diversification benefits

The U.S. market may have outperformed the rest of the world over the last decade, but this wasn't always the case. Older investors may remember the "lost decade" of 1999 – 2009. During this period, U.S. markets returned an annualized 1.71%, while emerging markets returned 13.74%. 

During this time, the U.S. market endured not only a three-year bear market after the 2000 Dot-Com Bubble, but also the 2008 Great Financial Crisis and years of stagnant returns in between. It wasn't until 2010 that U.S. markets began their decade-long bull run again.

There's also the matter of correlations to consider. Generally, investors should consider adding assets with less-than-perfect correlations with their portfolio that still possess a positive expected return. Dividend-generating emerging market ETFs fit this profile perfectly as seen below.

While U.S. markets pulled ahead strongly in recent years, there is no guarantee that this will continue for the next decade, especially given that U.S. valuations are still much higher than emerging market valuations (more on this below in the next section). 

Simultaneously, there is historical evidence that points to extended periods of emerging market outperformance when the U.S. market falters. As Mark Twain once remarked: " “History never repeats itself, but it does often rhyme.” Why bet your entire portfolio on the U.S.?

Factor exposure benefits

The Fama-French value risk premium is a well-documented factor when it comes to explaining a portion of long-term equity returns. To quote Warren Buffett: "A too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments."

WisdomTree themselves note that DEM's backwards-looking yield is currently sitting at 10.60% as of February 21st, around October 2008 Great Financial Crisis levels. Generally, a higher yield corresponds to depressed share prices. T.Row Price notes in a March 2022 whitepaper that a combination of value and dividend‑paying stocks appears favorable for long‑term investors.

Currently, valuations in emerging market dividend ETFs like DEM and DGS are also substantially lower compared to U.S. equities. According to Portfolio Visualizer, the SPDR S&P 500 ETF (SPY) currently has a price-to-earnings (P/E) ratio of 20.33, compared to just 5.52 for DEM and 7.28 for DGS. 

Moreover, by running a factor regression on a monthly return basis over a 36-month roll period, we find that DEM has historically produced statistically significant loadings for value, while DGS has historically produced statistically significant loadings for value and size. 

Compared to the overall emerging market blended cap indexes, DEM offers palpable value exposure. Notable, this combination makes DGS a possible candidate for an emerging market small-cap value ETF, an offering currently missing in the U.S. ETF industry.

Investors interested in DEM and DGS can find multiple reasons to be bullish, whether in terms of high dividend yields, low valuations, or potent factor exposures. For those looking for enhanced emerging market exposure beyond the usual market cap-weighted blended-cap index ETFs, these ETFs could be excellent augments or substitutes. 

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.