The easiest way to buy emerging-market income stocks, which provide a useful alternative to North American dividend payers, is through US-listed ETFs, writes Shirley Won of The Globe and Mail.
Investors in search of better dividend yields than they can get in Canada or the United States now have a new hunting ground: emerging markets.
Countries such as Brazil and China have traditionally been regarded as risky frontiers, best left to investors who are prepared to endure stomach-wrenching ups and downs in search of potential growth stars.
However, analysts say maturing economies and lush dividend yields are making many emerging-market companies attractive to people in search of steady income...as well as a dash of growth.
"There is a certain attractiveness in the combination of yield and growth that exists in emerging markets," says Nicholas Smithie, a strategist with UBS Securities. "The dividend yield in emerging markets [between 3% and 3.5% for the MSCI index] is higher than the dividend yield in America, and higher than any government bond in the Western world."
The easiest way to buy emerging-market dividend stocks is through US-listed ETFs such as iShares Emerging Markets Dividend, SPDR S&P Emerging Markets Dividend, and WisdomTree Emerging Markets Equity Income (see below for tickers and descriptions). In Canada, there is also the Redwood Emerging Markets Dividend mutual fund.
Companies in emerging markets are cheap, trading at about ten times forward earnings, Smithie said. In addition, many pay out only a relatively small portion of their earnings. "These companies have the capacity to substantially raise their dividend payouts," he said.
Brazil, South Africa, and Taiwan are among the top destinations for dividend hunters. "In Brazil, corporate law requires a minimum of 25% of profits to be distributed to shareholders," Smithie said.
"In South Africa, companies tend to be run in the interests of shareholders...They have a huge pension and mutual-fund industry that probably demands the income. In Taiwan, [technology] companies are very cash-rich, but with relatively scarce growth opportunities, unless you have tablet or smart-phone offerings or are an Apple (AAPL) supplier."
Several emerging markets are now maturing to the point where companies no longer have to spend huge amounts on building basic infrastructure, and therefore can hike dividends.
A good example is China Mobile (CHL), where revenue growth has fallen to single-digits. The Hong Kong-based company has raised dividends to keep investors happy, and because it can't find ways to invest cash, said Edward Lam, a portfolio manager with London-based Somerset Capital Management LLP.
"One of the things not understood by the market is that the whole rate of growth of emerging markets is slowing," so dividends will become more important as a source of returns, said Lam, who runs Redwood Emerging Markets Dividend Fund.
The fund manager, who owns stocks such as South African supermarket chain Shoprite Holdings and Indian luggage maker VIP Industries, won't jump on just any dividend play. For instance, OAO Gazprom in Russia doubled its dividend late last year, but Lam is steering clear, in part because he suspects the increase was prompted by a need for cash by the Russian state, which owns half of the natural gas giant.
Fund analyst Dan Hallett of HighView Financial Group said Canadian investors might consider emerging-market dividend funds for diversification, given that the domestic stock market is so heavily weighted with financial-service firms and utilities. There is also potential for gains from currency appreciation versus the Canadian dollar, he added.
But investors should be aware that foreign dividends may be subject to withholding taxes that can slice 15% to 20% off payouts, he said. Canadian dividends get preferential tax treatment. [This article was written for a Canadian audience, so Americans interested in their potential tax liability should contact their tax advisor, accountant, or financial advisor—Editor.]
Morningstar ETF analyst Patricia Oey suggested that one way to think of emerging-markets dividend ETFs is as a lower risk way to play the high-growth story in developing countries.
"Emerging markets are very volatile, so I wouldn't use them as a substitute for a US or Canadian domestic dividend fund," she said. "But if you are investing in emerging markets, dividend funds are attractive. They tend to be less volatile...and they are yielding maybe 4% or 5%."