There May Be Value in the Emerging Markets—If You Know Where to Look

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.   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.   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.