We believe the quality factor is one of the most intuitive and widely adopted factor premiums in investor portfolios.

• The idea: Over time, highly profitable companies with little debt should outperform less profitable firms with high debt loads.
• The adoption: WisdomTree’s Quality Dividend Growth suite shows how investors have used this idea in portfolios:
  • The WisdomTree U.S. Quality Dividend Growth Fund (DGRW) is WisdomTree’s largest equity fund with nearly $15 billion in assets
  • The WisdomTree International Quality Dividend Growth Fund (IQDG), the WisdomTree International Hedged Quality Dividend Growth Fund (IHDG) and the WisdomTree Global ex-U.S. Quality Dividend Growth Fund (DNL)¹ together have over $4 billion in assets
• The WisdomTree U.S. Quality Dividend Growth Fund (DGRW) is WisdomTree’s largest equity fund with nearly $15 billion in assets
• The WisdomTree International Quality Dividend Growth Fund (IQDG), the WisdomTree International Hedged Quality Dividend Growth Fund (IHDG) and the WisdomTree Global ex-U.S. Quality Dividend Growth Fund (DNL)¹ together have over $4 billion in assets

The disappointing returns of emerging markets (EM) in recent years have led many investors to reduce allocations or avoid EM altogether.

We believe that the same principles that “work” for investing in developed markets (DM), like choosing high-quality companies, can also work in EM.

The WisdomTree Emerging Markets Quality Dividend Growth Fund (DGRE) is one way to invest in these high-quality companies in EM.

Last spring, the Fund’s exposure to China was lowered to 0% as part of a strategic decision to mitigate the volatility associated with the market and provide investors a broad-based ex-China EM option.

Over the last year, the Fund has outperformed the MSCI Emerging Markets Index without the incremental volatility of the China exposure.

Figure 1: Total Annual Returns

Quality in Emerging Markets

One way to test how strong a factor is, is to see if it performs well in various markets.

The below chart compares returns from DM and EM for companies with high profits versus those with low profits. Since 1991, high-profit companies in both DM and EM have shown similar extra returns.

Over the last one- and three-year periods, high-profit companies in EM have done even better than those in DM.

Figure 2: Annualized Performance Spread: High Profitability vs. Low Profitability Portfolios

DGRE: Rules-Based Active

DGRE is a rules-based active Fund. The model selects 250–300 dividend-paying companies based on dividend safety measures, profitability metrics and dividend growth rates.

Many investors don’t think of dividends outside of DM. There is arguably an even greater case for looking to dividends in EM where there can be greater questions around accounting standards and earnings reliability. A dividend paid cannot be manipulated and cannot be restated.

The below graph shows the average tilts to higher return on equity (ROE) quintiles for DGRE relative to the MSCI EM Index over the last three years.

On average, DGRE has had more than 20% greater weight to the highest two ROE quintiles with under-weight allocations to the lowest ROE quintiles and the group of negative return companies.

Figure 3: 3-Year Average ROE Quintile Active Weights: DGRE vs. MSCI EM Index

October Portfolio Rebalance

DGRE is rebalanced at minimum each October with the discretion for ad hoc rebalances throughout the year. The most recent rebalance became effective at the close of October 16.

The below table shows the top 10 DGRE holdings before (old) and after (new) the rebalance. The only adds to the top 10 holdings were International Container Terminal Services (three-year annualized dividend growth of 30%) and HDFC Bank (three-year annualized dividend growth of 44%).

Taiwan Semiconductor Manufacturing Company—maintained as the top holding in DGRE—has consistently been one of the fastest dividend growers globally over the last several years, growing at over 11% annualized over the last five years.

Figure 4: Top 10 Holdings

The weighting process for DGRE is modified market cap to give greater weight to companies with higher scores on quality and dividend growth. To reduce turnover, constituents that are maintained in the basket are held at a weight that is roughly equal to what it was prior to the rebalance.

The one-way turnover for the Fund at rebalance was 19%.

After the rebalance, DGRE's dividend yield and price-to-earnings (P/E) ratio are roughly in line with the MSCI EM Index.

As the process favors quality companies earning a high ROE, the ROE advantage over the broad MSCI EM Index was improved. The implied fundamental growth rate (ROE x earnings retention ratio) advantage over the benchmark was also increased.

Relative to the MSCI EM ex-China Index, valuations are slightly lower on P/E with an even greater improvement on the implied fundamental growth rate than versus the broad MSCI EM Index.

Figure 5: Fundamentals Comparison

From a sector perspective, the changes were modest. All sector weights are within 5% of the MSCI EM Index. The most notable change was an increase to Financials (+5%).

Figure 6: Sector Exposures

Country changes were similarly minor. The most notable change was an increase to Taiwan (-5%). The 0% China exposure and the resulting over-weight allocation to India of over 10% has been consistent since the May 2023 rebalance.

Figure 7: Top Country Exposures

Conclusion

We know investors are familiar with quality investing in their DM allocations. We believe DGRE offers a unique exposure to quality dividend growers in EM.

Recent knee-jerk responses to China stimulus have investors skittish about whether now is the time to dive into EM, or if the best-case scenario for China has already been priced in.

DGRE and its 0% exposure to China allows investors to access the upside potential of EM without the headache of timing a China allocation.

¹ Includes both developed and emerging markets exposures.