DVYE - DVYE: Emerging Markets ETF Strong 9.0% Yield Cheap Valuation Risky Holdings

2023-06-06 09:24:31 ET

Summary

• International stocks trade with discounted prices and valuations. Emerging market stocks doubly so.
• iShares Emerging Markets Dividend ETF is a simple emerging markets ETF, offers exposure to cheap emerging market equities, and yields 8.8% to boot.
• The fund is a strong, high-yield investment, but quite risky, too.

Author's note: This article was released to CEF/ETF Income Laboratory members on May 22nd.

The iShares Emerging Markets Dividend ETF ( DVYE ) is an emerging markets high-yield equity index exchange-traded fund, or ETF. In my opinion, DVYE's strong 9.0% dividend yield and cheap valuation make it a buy. The fund's holdings are much riskier than average, due to focusing on emerging markets and high-yield stocks. Due to this, the fund is generally only appropriate for more risk-seeking investors and retirees.

DVYE - Basics

• Investment Manager: BlackRock
• Underlying Index : Dow Jones Emerging Markets Select Dividend Index
• Expense Ratio: 0.49%
• Dividend Yield: 9.02%.

DVYE - Overview

DVYE is an emerging markets high-yield equity index ETF. It tracks the Dow Jones Emerging Markets Select Dividend Index, an index of these same securities. It is a simple index, investing in the 100 highest-yielding emerging market equities, subject to a basic set of liquidity, trading, profitability, etc., criteria. Country weights are constrained, to ensure diversification across countries. Rules and buffers constrain turnover rates. It is a dividend-weighted index: higher yield equals larger weight.

DVYE is reasonably well-diversified across countries, with investments in over a dozen countries. The three largest of these, China, Brazil, and Taiwan, account for over 50% of the fund's portfolio.

Industry diversification is quite high, too, with sizable investments in most relevant industries.

DVYE is overweight old-economy industries, including materials, energy, and utilities, as these are overweight in emerging market economies, and as these tend to sport comparatively strong yields. On the flipside, the fund is underweight tech and healthcare, for the opposite reasons (not a ton of Brazilian tech or pharmaceutical corporations).

Industry exposures impact DVYE's relative performance. Performance should be comparatively weak when tech outperforms, comparatively strong when old-economy industries outperform. Due to past emerging market equity weakness this is not readily apparent, but it should be the case moving forward, considering the fund's industry exposures.

DVYE focuses on some of the highest-yielding emerging market equities, which results in a strong 9.0% dividend yield.

Besides the above, nothing much else stands out about the fund's index, strategy, or portfolio. Let's now have a look at the fund's benefits.

DVYE - Benefits

DVYE focuses on high-yield emerging market equities, which results in a strong dividend yield, a very cheap valuation, and exceedingly strong potential total returns.

DVYE's yield is pretty self-explanatory, with the fund offering investors a strong 9.0% yield. It is an incredibly strong yield on an absolute basis, and much higher than that of most well-known equity indexes.

DVYE's yield is also quite a bit stronger than that of most well-known dividend ETFs, including the Vanguard High Dividend Yield Index Fund ETF Shares ( VYM ) and the Schwab U.S. Dividend Equity ETF ( SCHD ).

It is not higher than some of the highest-yielding ETFs, including some covered call funds. These have reduced potential capital gains, however, and are not comparable to DVYE in this regard.

In most cases, ETFs distribute any and all income generated to shareholders as dividends and nothing else , so ETF dividends are generally covered by underlying generation of income. That is the case for DVYE as well, as evidenced by the fund's 11.8% SEC yield.

SEC yields are a standardized measure of a fund's underlying generation of income, and tell us just how much in dividends is the fund itself receiving. DVYE's 9.0% yield is more than covered by its 11.8% in income, which adds a great deal of safety and potential growth to the fund's dividends. Owing to the inherent risk in most emerging market equities, I would not characterise the fund's dividends as safe, but what data we have is encouraging, at least.

Cheap Valuation

DVYE focuses on emerging market equities, which tend to trade with heavily discounted valuations. Valuations are a bit cheaper now than in the past too, owing to continued U.S. equity strength, and bearish investor sentiment in the aftermath of the coronavirus pandemic. DVYE further focuses on high-yield equities, which tend to trade with cheap prices and valuations, too (expensive stocks rarely have high yields). The result is a portfolio with an incredibly cheap valuation, much lower than that of most equity indexes.

DVYE's cheap valuation could lead to significant capital gains, contingent on valuations normalizing. Now, as emerging market equities generally trade with discount valuations, some cheapness is to be expected, and DVYE is incredibly unlikely to ever see P/E ratios in the 20s like is the case for the S&P 500 Index (SP500). Still, some gains seem possible, considering the fund's level of cheapness, the fact that international stocks are cheaper than their historical average:

and considering DVYE's historically high dividend yield:

Point being, DVYE is generally a cheap fund, but it seems to be much cheaper now than in the past, which points towards higher share prices, and hence strong capital gains for shareholders. On a more negative note, these gains are contingent on improved market sentiment, and so are far from certain. Sentiment has significantly improved for most cheap, undervalued equity sectors since at least 2022. Emerging market equities have been one of the few exceptions, with these stocks seeing below-average performance in the recent past.

In general terms, I believe that valuations will normalize sooner or later, as prices and returns do tend to track fundamentals. Still, I've thought as much for quite a while now, and emerging market equity valuations have refused to budge.

DVYE's strong dividends do ameliorate the above somewhat, as these are not dependent on investor sentiment, and could lead to strong, market-beating returns even if share prices remain stagnant. I've covered several high-yield funds for which this has been the case in the past, including the iShares Latin America 40 ETF ( ILF ) and the VanEck BDC Income ETF ( BIZD ). It has not been the case for DVYE, which brings me to my next point.

DVYE - Drawbacks

Risky Holdings

DVYE is an incredibly risky fund. It focuses on emerging market equities, which are riskier than average due to their comparatively weak economies, corporate governance issues, and foreign currency risk. Sentiment and perceptions of risk play a role too, as investors flee emerging markets when times are tough. DVYE further focuses on high-yield stocks, which boosts risks further: high yields come at a price, and in many cases that price is risk. Safe stocks basically never yield 9.0%, and the same is true for equity funds.

DVYE's risky holdings increase portfolio risk and volatility, and could lead to outsized losses and underperformance. Importantly, they have led to sizable losses in the past, for a very specific reason: the Ukraine War. DVYE is, well, a high-yield emerging market equity fund, and one of the highest-yielding emerging markets in early 2022 was Russia. Russian stocks traded with heavily discounted prices at the time, due to fears of Western sanctions and a possible war. Fears were proven right, with Russia invading Ukraine in February of that year, and Western governments sanctioning Russia in response. Stock prices collapsed, with several asset managers, including BlackRock, effectively writing off their Russian investments .

DVYE was heavily invested in Russia at the time, with Russian stocks accounting for around 20.0% of the fund's portfolio. DVYE still technically holds these stocks, at less than a penny per share. Losses were roughly equal to around 20.0%.

Dividends declined by a bit less, due to higher dividends in other portfolio holdings / countries.

The losses above were incredibly detrimental to the fund and its shareholders, and a stain on its performance and dividend growth track-record. As can be seen above, DVYE's dividends were generally seeing positive growth, minus a pandemic hiccup in 2020, until the war. Performance was fine, too, with the fund performing in-line with some of its peers until the war (pay attention to the large drop in the fund's returns in early 2022).

DVYE's subpar performance and dividend growth track-record are both important negative for the fund and its shareholders. In my opinion, the key negative is the fund's risky holdings, as these were ultimately responsible for the losses and dividend cuts in the past, and could lead to further losses in the future.

Right now, the key risks in the fund's holdings are the sizable investments in Chinese and Taiwanese stocks, with these accounting for 21.7% and 14.3% of the fund's holdings, respectively.

Chinese and Taiwanese stocks would almost certainly suffer significant losses if China were to invade Taiwan, a distinct possibility . Total losses are possible, as happened with Russian stocks. A war is far from certain, but it could happen, and it is an important fact for investors to consider. Although this might sound a bit vacuous, I do think it is important: there are very few countries or funds for which this is a concern.

As a final point, I've been quite bullish about DVYE in the past, and the fund has significantly underperformed since, due to the aforementioned issues with Russia. In all honestly, I got blindsided by the Ukraine War, which I did not see coming at all. DVYE was generally doing fine before that, but not outperforming.

Conclusion

iShares Emerging Markets Dividend ETF is an emerging markets high-yield equity index ETF. In my opinion, DVYE's strong 9.0% dividend yield and cheap valuation make it a buy.

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