SDEM - SDEM: Don't Fall For This Monthly Income ETF

Summary

• SDEM is a high-yield emerging market ETF paying monthly distributions.
• It holds 50 of the highest-yielding EM stocks with heavy exposure to China, Taiwan, and Brazil.
• Its sector and country allocations carry significant risks, from politics to war to currency volatility.
• With so many safer high-yield ETF and CEF options out there, I recommend that investors steer clear from SDEM.

As I recently discussed in my coverage of their cloud computing ETF ( CLOU ), Global X, a subsidiary of South Korea's Mirae Asset Financial Group, offers one of the widest selections of niche sub-sector, thematic, and special strategy ETFs. Today I'll be taking a look at another Global X offering, the MSCI SuperDividend Emerging Markets ETF ( SDEM ), to see if it has any appeal for income investors looking to boost their yield and/or international exposure.

A Caveat For Monthly Income Investors

In today's higher-interest-rate environment, many investors are looking to increase their portfolio's yield in order to keep up with inflation and rising borrowing costs. To meet this desire, a plethora of high-yield ETFs and CEFs have been launched in the past decade to varying degrees of success. Funds that pay monthly distributions are naturally very attractive to investors who rely on dividends as their primary source of income, both for the consistency and frequency of their payouts and for the higher overall yields they often boast. And for growth investors who reinvest their dividends or distributions, these types of funds can also be appealing for their extra wealth compounding potential.

Unfortunately, with the exception of some long-term successes like STK, BST, BME, UTG, and UTF, relatively few high-yield income funds do well over the long term, usually because their NAV growth fails to sustain their high payout requirements for one reason or another. The former investment advisor in me is always on the lookout for retail investment products that seem too good to be true or that use misleading or confusing advertising to appeal to everyday investors, and the high-yield space seems to be rife with them. So before considering adding a monthly income fund such as SDEM to your portfolio, I strongly encourage you to do your own due diligence on its underlying index, marketing claims, distribution history, and historical total returns before making a decision.

While Global X is a respected fund provider and I certainly don't think that they are intentionally misleading investors with their marketing materials, in my opinion their ETF lineup could benefit from a bit more focus to more closely align with investors' best interests, which I think we'll see by taking a closer look at SDEM.

Risk On Top Of Uncertainty

SDEM is a small ETF launched in 2015 with $45M in assets, an 8.25% TTM distribution yield, and a 0.67% expense ratio. Its forward yield is difficult to pin down due to currency fluctuations and the absence of a set distribution amount, as a quick glance at its distribution history shows:

This already puts the fund at a disadvantage for income investors, as most monthly income CEFs and stocks offer set payouts and relatively predictable yields. Still, SDEM has managed to pay monthly distributions since its inception, which is...something.

Historical returns don't fare any better, as we can see that those distributions haven't made up for SDEM's negative total return since inception. In fact, SDEM has underperformed both the S&P 500 and the emerging markets index ( VWO ) by large margins despite its focus on dividend-paying companies.

A common criticism of monthly income funds is true in this case: SDEM investors would have been better off simply holding VWO and making monthly withdrawals to match SDEM's income stream.

While its relative underperformance could make SDEM an interesting turnaround candidate amidst increasing interest rates in much of the world, its risky sector and country exposure give me reason to think otherwise. One of the biggest risks facing the market in the coming years is a potential China-Taiwan conflict, which is currently predicted to reach a head sometime between 2025 and 2027, and SDEM's largest exposure by far is to those two countries, with over 50% of its holdings domiciled in either China or Taiwan:

As if that weren't concerning enough, over 50% of SDEM's holdings are in the volatile materials and energy sectors. These sectors are extremely cyclical, and while China's economic reopening holds promise for its mining and energy stocks, on a longer-term basis I wouldn't want to be caught holding them if and when a Taiwan conflict breaks out. In my opinion, investing in the Chinese market can make sense in a more targeted, short-term way, but presumably one wants to hold an income ETF like SDEM for its long-term income stream and not for short-term capital gains where a highly liquid ETF like MCHI, GXC, or VWO would be more ideal.

SDEM's third-largest country exposure is to Brazil, which I'm more optimistic about in the long term. However, Brazil's tumultuous political landscape could prove difficult for materials and energy stocks should the new president Lula da Silva's plans to increase sustainability, reduce emissions, and open free markets for energy distribution cut into growth and profits for the major players in those sectors.

Questioning The EM Investment Thesis

SDEM invests in 50 of the highest-yielding stocks in emerging markets that have increased their dividend and/or payout ratio from the previous year, ranked by dividend yield. Since "emerging markets" can be hard to define in a rapidly changing world, here is the current official list from SDEM's underlying index provider, MSCI:

EM countries include: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Kuwait, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Saudi Arabia, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates.

One of my pet peeves in investing is the idea that an emerging markets fund is a must-own part of any diversified portfolio, as devotees of Modern Portfolio Theory often suggest. I have never understood the reasoning behind this, as "emerging markets" has always been a highly subjective assemblage of countries with entirely different cultures, economies, political systems, and risk factors. Just as we now rightly correct those who think and speak of "Africa" as a single homogenous country, I think investment advisors, wealth managers, and fund and pension providers should stop treating such a diverse group of countries as a single entity for the sake of being able to foist mediocre EM ETFs onto retail investors.

Looking at SDEM's marketing blurbs above, we can see that Global X posits that emerging markets are expected to "grow at a faster pace than developed markets." While this statement may be true for some of the countries listed above, I find it a bit misleading because faster economic growth does not necessarily translate into stock market outperformance.

Moreover, historical returns show that regardless of the extra value and growth potential offered by emerging market stocks, as a group these indexes have performed quite poorly compared to developed markets. In fact, SDEM's Dividend 50 index has delivered a miserly 1.78% total return over the past 15 years!

This is why I have to call out Global X for branding this as a "SuperDividend" ETF when there is clearly nothing super about it. Not only has its index underperformed the broader EM index since 2008, but it also has an average annual return far lower than its yield. So when SDEM's marketing materials boast of "potentially increasing a portfolio's yield", they should probably also mention that it will also potentially decrease your expected returns.

Even after its recent run-up due to China's reopening, SDEM's price remains nearly 50% below inception, so while monthly distributions are nice, they shouldn't justify the long-term risk of losing a significant portion of your invested capital.

A Foregone Conclusion

It's no secret that I am biased against these types of ETFs: namely, ones that have no compelling reason for existing beyond enticing income investors with a high yield and a flashy name. With SDEM, the fact that a company pays a dividend is not an adequate substitute for a quality screen, and the volatile, economically sensitive nature of its sector and country exposures means that any gains could be wiped out quickly should the geopolitical winds suddenly change.

With significant sector and geopolitical risk, an unpredictable yield, low liquidity, poor historical returns, and an unclear investment thesis, I rate SDEM a sell and encourage investors looking for monthly income and geographic diversification to look elsewhere.

For better options with a similar monthly yield, I would highly recommend looking into the Cohen & Steers Infrastructure Fund ( UTF ) and the Reaves Utility Income Fund ( UTG ), both of which boast longer distribution records, more consistent payouts with long-term distribution growth, and much greater historical returns.

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