Emerging market ETFs: A steadier strategy, fast growth

@Money November 28, 2011: 12:44 PM ET
emerging markets investing

(MONEY Magazine) -- Coming out of the 2008 financial meltdown, emerging markets were a rare bright spot: Places like Brazil, China, and India delivered fast economic growth and double-digit stock gains. But the price you pay for venturing into exotic markets is the risk of sudden, sharp losses.

Case in point: Since the start of the year, when the global recovery stalled, emerging-market funds have sunk 15.6%, vs. a 0.4% gain for the S&P 500.

Wouldn't it be great if there were a way to capture the developing world's rapid growth with fewer bumps along the way?

There is. Several exchange-traded funds have been launched recently that track stock indexes made up of dividend payers in the emerging markets. Among them: WisdomTree Emerging Markets Equity Income (DEM), which is down 9% this year, and SPDR S&P Emerging Markets Dividend (EDIV), which opened its doors in February and has a three-month loss of 13.8%. The benchmarks followed by such ETFs yield about 7%, vs. around 2% for the S&P 500.

Normally you should be wary of new funds that claim to let you have your cake and eat it too.

Confused about investing overseas? Send your questions to The Help Desk.

What's more, a focus on income may seem counterintuitive here, since dividends are associated with slower-growing companies.

But in the emerging markets, dividends are often a show of strength, says Stuart Reeve, co-manager of BlackRock Global Dividend Income (BABDX). Dividend payers have sufficient cash to grow and don't need to issue new stock to raise capital, which dilutes the value of existing shares, he says.

Before you race too quickly into these funds, though, there are some things you ought to know:

Don't count on steady income.

There's no guarantee these funds will keep yielding close to 7%. Plus the risk of steep plunges due to political and economic instability can eat into your payouts.

You'll pay additional taxes and fees.

These ETFs carry somewhat higher expenses -- 0.63% of assets for DEM, vs. just 0.22% for Vanguard MSCI Emerging Markets ETF (VWO). And you'll pay overseas taxes on distributions, though taxable investors who itemize can get a foreign credit or claim a deduction.

You won't get full diversification.

Funds that screen for high payers must often focus their bets. DEM has around 40% of its assets in Taiwan and Brazil, and roughly 25% of the portfolio is in financials. That's why Morningstar analyst Samuel Lee suggests splitting your emerging-markets stake between dividend ETFs and more diversified offerings.

There's one more thing. You know that Wall Street has a knack for complicating good ideas. So if you're going to try a dividend strategy here, it may pay to act now before the ETF engineers muck up a pretty good thing.  To top of page

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