EEM - DEM: Strong Recently But Longer-Term Mixed

2023-10-23 10:15:22 ET

Summary

• WisdomTree Emerging Markets High Dividend Fund has had a cyclical performance, underperforming from 2014 to January 2021 but showing strength since 2021.
• DEM focuses on higher-yielding sectors and has significant investments in Taiwan and China.
• Despite geopolitical risks and currency risk, the long-term growth prospects of emerging markets and DEM's dividend strategy could offer attractive returns.

And I had an old-fashioned idea that dividends were a good thing." - James MacArthur

No part of the investable landscape has been more difficult to be an investor in than emerging markets. Over the past decade, emerging markets have gone nowhere, and it doesn't matter if you focused on growth stories or pure dividend plays. To that end, one might have thought that dividend-focused emerging market proxies would have done a lot better than broad-based plays. It's actually been far more cyclical than most would otherwise think.

Launched in 2007, the WisdomTree Emerging Markets High Dividend Fund ( DEM ) primarily invests in high dividend-yielding stocks from emerging markets. With an expense ratio of 0.63%, DEM has a significant pool of assets under management, amounting to approximately $2.47 billion. This fund's investment strategy reflects WisdomTree's belief in the value of dividends as an objective measure of a company's health and profitability. DEM's dividend-weighting approach, it was hoped, could increase returns or reduce volatility compared to traditional market cap-weighted strategies.

The problem is that it has but not in a consistent longer-term way. If we look at the ratio of DEM relative to the iShares MSCI Emerging Markets ETF ( EEM ), it made new relative highs and has been incredibly strong since 2021, but from 2014 to January 2021 it meaningfully underperformed.

DEM's Portfolio Composition

One of DEM's unique features is its focus on the higher-yielding sectors. It has significant investments in the Financials, Information Technology, Materials, and Energy sectors. The fund also has substantial geographical concentration, with more than 40% of its assets invested in Taiwan and China.

These strategic allocations are underpinned by the fund's investment process, which involves a series of stringent selection criteria. Dividend-paying companies are selected from the emerging markets, further screened by their dividend yield, and finally analyzed for risk. Again - it certainly has been a source of alpha since 2021, but for the most part didn't add much to the portfolio relative to broader based emerging market funds prior to that.

Comparison with Other ETFs

In comparison with other similar ETFs in the market, DEM offers a competitive proposition. The history of higher dividends is clearly a differentiator, even though again only recently has the total return favored DEM over other more core emerging market funds. I would caution anyone to consider buying based on dividends alone though, despite relative momentum clearly working against other emerging market proxies more recently.

Future Outlook and Risks

I've talked about the long-term case for emerging market outperformance in the past against US markets (and have clearly been wrong so far), but I do think in general emerging markets remain a part of the marketplace one should have some exposure to. The major issue when it comes to DEM is the significant exposure to Taiwan and China, both of which carry geopolitical risks. Any escalation in the tensions between these two countries could negatively impact the fund's performance. Furthermore, the currency risk associated with investing in emerging markets could also affect returns.

Notwithstanding these risks, the long-term growth prospects of emerging markets remain promising. DEM's focus on high dividend-yielding stocks from these markets could potentially offer attractive returns in the future. Perhaps we are in an era where dividends will continue to matter more in a higher interest rate environment. Just be mindful that like everything else, as a methodology for weighting, it has cycles too.

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