Emerging markets stocks: Volatility, yes, but dividends too

New American Funds offering seeks to take advantage of strong payouts but some doubt strategy

Mar 11, 2014 @ 12:01 am

By Trevor Hunnicutt

Every prospectus for funds invested in emerging markets has a page dedicated to risks like volatile currencies and performance. Emerging markets have certainly delivered on that possibility in recent months, with several countries dogged by fears of a taper-driven slowdown.

What investors may be less aware of is the fact that those countries' publicly traded companies also delivered the fastest growth in dividend payouts of any region last year, according to Henderson Global Investors, an asset manager.

That contradictory environment is the one into which Capital Research and Management Inc.'s American Funds launched its newest fund last week.

“We're currently in a period of time [in which] the currencies have been quite weak, the economies have slowed down,” said Shaw B. Wagener, a portfolio manager for the American Funds Developing World Growth and Income Fund (DWGAX). “That combination actually makes the start-up time for a fund like this really good … we feel like we're getting closer to the end of that cycle than the beginning.”

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'MORE RESISTANT'

The fund focuses on investing in dividend-paying emerging-markets stocks, which the company thinks will be “more resistant to market declines than stocks of companies that do not pay dividends,” according to the fund's prospectus.

The fund managers aim to invest a minimum of 80% of assets in emerging-markets companies or companies that generate at least 50% of revenue from emerging markets, according to the prospectus.

Mr. Wagener said the fund was different from similar offerings on the market, including passively managed, index-based funds such as iShares Emerging Markets Dividend (DVYE), EGShares Low Volatility Emerging Markets Dividend (HILO) or the WisdomTree Emerging Markets Equity Income (DEM) because the fund manager is actively looking for companies that can deliver not just dividends but growth. He said many emerging-markets dividend funds are invested in companies that are “very mature” with limited or declining growth prospects.

“We're pretty far from 'me-too,'” Mr. Wagener said.

Growth-oriented companies that return capital are showing an important savvy in what kinds of growth they invest in, causing them to deliver better earnings prospects in good markets and bad, according to Mr. Wagener.

“Companies that have the ability to see through what is of the moment versus what is more secular and invest on that basis results in them being much better investors of capital,” he said.

Still, not all investors are convinced.

“A dividend strategy is a bad one in my opinion and the reasons are [that] most stocks don't pay dividends,” said Larry Swedroe, director of research for the BAM Alliance, the network of independent advisory firms.

SECTOR BIASES

While dividends do signal quality, buying companies based solely on that factor creates sector biases, he said.

The evidence shows that sector bias is likely to be the case for investors looking to harvest dividends in the emerging markets. More than 58% of dividends in emerging markets came from two sectors in 2013: financials and oil, gas and energy. Consumer basics, discretionary and technology accounted for just a combined 10% of the dividends.

Mr. Swedroe prefers index funds weighted toward fundamentals like price-to-cash-flow or price-to-earnings. But for investors insistent on a dividend bent, beginning to buy dividend-payers outside of the U.S. would add welcome diversification, he said.

Emerging markets paid more than 12% of the nearly $1.03 trillion in global dividends last year, growing 9.1% from their share in 2012.

The so-called BRIC countries — Brazil, Russia, India and China — generated more than half of those dividends. In many cases, the companies paying them are still owned in large part by entrepreneurs and government entities, rather than the general public, which could put pressure on those companies to return capital to investors, according to Henderson Global's report. The company offers its own fund, Global Equity Income Fund (HFQAX), which searches for income in international stocks, including developed markets.

And in some countries, such as China, the largest dividend payer in the emerging markets, some companies are required by law to pay a certain rate of dividends. Other companies that trade on foreign exchanges are strongly encouraged to do so.

Emerging markets have been seriously tested since last May, as a result of worries about Chinese economic growth and the effect of the Federal Reserve tapering its bond-buying program.

Analysts say the program, known as quantitative easing, depressed yields and sent investors across borders searching for enhanced returns. So when the Fed began in January to cut back its multibillion-dollar bond-buying program, emerging markets tumbled as investors fled.

Facing both dropping currencies and stocks, investors pulled nearly $9 billion from emerging-markets mutual funds and ETFs last month, according to Morningstar Inc.

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