In 2013 WisdomTree brought out what we believe to be a revolutionary way to focus Indexes on potential future dividend growth in equity markets around the world. One of the more interesting applications of the methodology thus far has been in emerging markets.
The Meaning of “Growth” and “Quality”
Since these words can mean so many different things when discussing equities, we want to start by clarifying what we mean:
Specifically long-term earnings growth expectations, focused on operating earnings over the next full business cycle, typically three to five years in duration.
A combined focus, weighted equally, on three-year average return on equity (ROE)
and three-year average return on assets (ROA)
. Looking at both measures generates a sensitivity to leverage
, penalizing those firms that may have high ROE but low ROA.
The Contrast of Dividend Growth vs. Dividend Yield in Emerging Markets
The WisdomTree Emerging Markets Equity Income Index
(EM Dividend Yield) provides a stark contrast to the WisdomTree Emerging Markets Dividend Growth Index
(EM Dividend Growth). The focus here isn’t on any measures of growth or quality but rather on potentially finding some of the most attractive valuation
opportunities in emerging markets.
Dividend Growth vs. Dividend Yield: Growth, Quality & Valuation
For definition of terms in the chart, please visit our Glossary.
• P/E Ratio
and Earnings Growth: EM Dividend Yield's
P/E ratio was more than 40% below that of EM Dividend Growth, but EM Dividend Growth’s median long-term earnings growth expectations were approximately 50% above those of EM Dividend Yield.
EM Dividend Growth’s ROE and ROA figures were also significantly higher than those of the other two Indexes shown, leading to a higher-quality bias and ultimately lower leverage.
Key Themes of 2014 Playing Out in Emerging Markets
What we’ve seen year-to-date through April 30, 2014, is that EM Dividend Growth has outperformed EM Dividend Yield by approximately 5.7% and EM Equities by nearly 3.9%.1
Why has this occurred?
Theme 1: Russia & China
Thus far in 2014 we’ve seen strong opinions among investors regarding state-owned enterprises—particularly energy firms in Russia and financial companies within China. These are some of the deepest pockets of value among emerging market equities, and EM Dividend Yield focuses a lot of weight here since it is a value-seeking strategy. On the other hand, EM Dividend Growth is more selective, and the largest state-owned Chinese banks did not qualify for selection, nor did the largest Russian energy firms.
Theme 2: Markets on the Comeback Trail
In 2013, equity markets within Indonesia and Thailand had a tough time. However, this was mostly driven by weakness in their respective currencies, with the Indonesian rupiah down 19.54% and the Thai baht down 6.47%.2
When currencies behave in this manner, we believe it speaks more to sentiment with regard to macroeconomic issues than to specific fundamentals
of underlying equities. Indonesian equities are generally characterized by high ROE and ROA compared to broad EM Equities, whereas Thailand’s equities are characterized by high growth prospects. Both markets have been coming back strongly in 2014, with Indonesia leading the 21 markets currently within EM Equities and Thailand not far behind in fifth position.3
Theme 3: Consumer Staples
The largest single sector over-weight of EM Dividend Growth relative to EM Dividend Yield is Consumer Staples—not surprising, as the sector has a P/E ratio above 20.0x.4
Strategies hunting for value in EM Equities would do well to avoid this sector, but as of April 30, 2014, EM Dividend Growth’s stocks in this sector had an ROE that was approximately twice that of EM Equities. A similar story held true for ROA.5
This was a greater than 16.0% over-weight for EM Dividend Growth versus EM Dividend Yield, and a nearly 10% over-weight for EM Dividend Growth versus EM Equities.
Conclusion: Not All Dividend Payers Are Created Equal
While some of the largest payers of cash dividends in emerging markets are Chinese financials and Russian energy firms, these aren’t the only payers of cash dividends in this region. EM Dividend Growth provides a very interesting contrast in exposure to EM Dividend Yield, and we believe it could be an interesting avenue through which to consider risk mitigation through a focus on higher-quality, higher-potential-growth companies.
Source: Bloomberg, with data covering 12/31/13 to 4/30/14
Source:Bloomberg, with data as of period 12/31/12 to 12/31/13
Source: MSCI, with data covering period 12/31/13 to 4/30/14
Refers to the P/E Ratio of the MSCI Consumer Staples Index as of 4/30/14. Source: Bloomberg