DEM - DEM: Emerging Market Index ETF Cheap Valuation Strong 6.0% Dividend Yield

2023-12-04 03:29:33 ET

Summary

• Although emerging market equities have traded with rock-bottom valuations for years, returns have generally been quite mediocre.
• DEM is one of the few exceptions, with the fund matching the performance of the S&P 500. It yields 6.0% too.
• An overview of the fund follows.

I last covered the WisdomTree Emerging Markets High Dividend Fund ETF ( DEM ) in early 2022. In that article , I argued that DEM's diversified emerging market holdings, cheap valuations, and strong yield, made the fund a buy. DEM has since significantly outperformed most other emerging market equity funds, while matching the returns of the S&P 500. Although fund performance was reasonably good, I did expect stronger absolute returns and outperformance.

DEM remains a diversified fund with a cheap valuation and a strong yield, so the fund remains a buy.

DEM - Basics

• Investment Manager: Global X
• Underlying Index: WisdomTree Emerging Markets High Dividend Index
• Expense Ratio: 0.63%
• Dividend Yield: 5.98%
• Total Returns CAGR 10Y: 2.25%

DEM - Overview and Analysis

Index and Holdings

DEM is an emerging market dividend index ETF, tracking the WisdomTree Emerging Markets High Dividend Index . It is a relatively in-depth index, which includes all relevant securities subject to a set of liquidity, yield, earnings, quality, momentum, and risk criteria. It is a modified market-cap-weighted index, which overweighs comparatively safe securities. There are country and industry caps to ensure diversification.

A quick graph summarizing the index selection process.

In my opinion, based on reading the index methodology, the index screening process is well-designed, and is likely effective in excluding low-quality companies, yield traps and worst-performing stocks. These screens seem particularly important for an emerging market equity ETF, considering the risks inherent in these markets.

DEM is a reasonably well-diversified fund, with exposure to over 400 companies from dozens of countries, and all relevant industry segments. Largest holdings are as follows.

Industry holdings are as follows.

As can be seen above, DEM provides exposure to most relevant industry segments. At the same time, the fund is significantly overweight energy (minerals), with more moderate overweight positions in (other) minerals and finance. As such, DEM is much more exposed to commodity prices and conditions in the energy industry than most equity indexes, including the S&P 500. Said exposure boosts risks and volatility, and is an important consideration for investors.

DEM's country weights are as follows.

As can be seen above, DEM invests in several emerging market countries, but is significantly overweight China and Taiwan. Said overweight position seems excessively risk, owing to the risk of a Chinese invasion of the island. I can't say I think an invasion is likely, but I'm not a military analyst, and I got blindsided by the Ukraine war before.

In my opinion, and owing to the above, investors should keep position sizes small. I would personally not go above 10%.

Valuation Analysis

International equities tend to trade at discounts to U.S. equities, as investors are generally willing to pay premium prices for the stability and growth offered by U.S. companies. Emerging market equities trade at discounts too, for the same reason, and due to their above-average risk.

DEM itself trades with a 7.3x PE ratio and a 1.0x PB ratio. In effect, the fund trades with a significant discount to U.S. and global equities, and a moderate discount to international and emerging market equities.

Cheaply valued equities and equity funds could see strong capital gains in the future, contingent on valuations normalizing. Equity markets have fluctuated wildly these past few years, but two important trends seem clear.

First, emerging market equities have seen stagnant prices and valuations, due to bearish investor sentiment and a strengthening dollar.

Second, energy equities have seen much higher prices and more expensive (less cheap) valuations, due to higher energy prices, improved investor sentiment, and significant buybacks and dividend hikes.

DEM invests in emerging market equities and is overweight energy, so the net effect from the above somewhat muted. In practice, the fund has tended to significantly outperform international and emerging market equity indexes, slightly underperform the S&P 500. This been the case since early 2022, and since I last covered the fund. Performance has been inconsistent, volatile, and strongly dependent on the exact time period analyzed / cutoff dates, however.

Long-term, I do believe that valuations tend to normalize, and that cheaply valued equities outperform. That has somewhat been the case for DEM these past few years, but only slightly so, and with a lot of volatility.

Dividend Analysis

DEM currently sports a 6.0% dividend yield. It is a strong yield on an absolute basis, and quite a bit higher than average for an equity fund.

On the other hand, the yield is lower than that of several niche income-producing asset classes, including BDCs, mREITs, and most CLOs. Some high-yield corporate bonds and funds yield more, but not most / on average. DEM's dividends are good, but not great.

DEM's dividends see significant fluctuations quarter to quarter, as some emerging marker issuers make irregular dividend payments, and others make semi-annual payments. Dividend fluctuations might make it difficult for retirees to do retirement planning if investing heavily in the fund.

DEM's dividends also fluctuate year to year. Growth has been slightly positive since inception, strong these past three years, but are down YTD, and by a lot. The long-term trend is definitely positive, but there is a lot of volatility here.

DEM's dividends are quite strong, but volatile. Dividends tend to grow, but cuts are common too. On net the situation seems beneficial for investors, but lots of funds have higher, more stable distributions, mostly in the fixed-income space.

Performance Track-Record

DEM's performance track-record is mixed, but mostly negative , with the fund significantly underperforming relative to U.S. and global equities since inception, and for the past decade. Underperformance was due to several factors, including a strengthening dollar, bearish market sentiment, a more expensive valuation, and long-term energy underperformance. Results are as follows.

Importantly, market conditions and fund fundamentals have materially improved these past few years. The dollar is higher, which means U.S. investors can access foreign markets at much better prices. At current prices, the dollar is less likely to go higher, reducing the probability of further foreign currency losses for DEM and its investors.

Sentiment has also somewhat improved, as evidenced by stronger international and energy returns these past few years (remember that DEM is overweight energy).

Valuation gaps between international and U.S. equities have also widened, to their highest levels in decades.

DEM's yield has just about doubled in the past decade. This is a direct, straightforward benefit for investors, and indicative of a much cheaper valuation (also beneficial).

DEM underperformed when market conditions were tougher, and fund fundamentals weaker. It has outperformed since early 2022, as market conditions improved, and fundamentals were stronger. As conditions and fundamentals remain good, I believe the fund will continue to outperform moving forward.

Conclusion

DEM's diversified emerging market holdings, cheap valuations, and strong yield, make the fund a buy.

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