Under The Hood: More EM Dividends

Typically prized for high GDP growth rates and diversification away from developed markets equities, emerging markets stocks and ETFs are making their presence felt on the income front as well. In 2012, the 300 largest non-financial firms in the MSCI Emerging Markets Index were expected to have paid $52.2 billion in dividends Barron's reported.

The added good news for investors is that stock-picking is not needed to tap into developing markets dividend growth because the number of ETFs devoted to this theme has surged over the past two years.

One of those ETFs is the SPDR S&P Emerging Markets Dividend ETF (NYSE:EDIV), which is now just a few weeks shy of its second birthday. Since its February 2011 debut, the SPDR S&P Emerging Markets Dividend ETF has hauled in almost $396.5 in assets, serving as further proof that investors are eager to put capital to work in the developing world, particularly if a decent yield is part of the proposition.

Indeed, EDIV obliges when it comes to yield. EDIV's 30-day SEC yield is a stout 6.22 percent and the ETF's trailing 12-month yield is 5.32 percent, according to State Street data.

Home to 123 stocks, EDIV is diverse at the sector level as five sectors materials, financials, telecommunications, utilities and technology receive double-digit allocations in the fund. EDIV offers exposure to 16 countries, but Taiwan and Brazil combine for over 39 percent of the ETF's country weight. At 11 percent, South Africa is the only other country that has a double-digit weight in EDIV. Turkey and China round the ETF's top-five country weights.

EDIV's index weights its constituents by annual dividend yield and caps individual stock weights at three percent. Weighting by dividend yield presents a double-edged sword investors need to be aware of. That methodology is clearly different than weighting by market capitalization, so it ensures that EDIV will not always be dominated by the stocks with the largest values. On the other hand, the yield bias could affect the quality of EDIV's top holdings.

Another concern is liquidity. EDIV's average daily volume is nearly 100,000 shares, but the fund's overall liquidity is not as robust as what is seen with the rival WisdomTree Emerging Markets Equity Income Fund (NYSE:DEM). As such, EDIV traded anywhere from 0.5 percent discount to a 0.5 percent premium to its net asset value on nearly 40 trading days during the fourth quarter of 2012, according to State Street data.

The ETF traded at premiums ranging from half a percent to one percent on 22 days, indicating that there were plenty of occasions in which investors arguably paid up for this fund.

While the yield weighting methodology may indicate investors are taking on added risk with EDIV compared to more familiar diversified emerging markets ETFs, EDIV does have some factors in its favor that should not be glossed over. For starters, the ETF's beta is just 0.87 compared to 1.51 for the iShares MSCI Emerging Markets Index Fund.

Additionally, EDIV's correlation to the SPDR S&P 500 over the past six months is just 0.73. Said another way, only two Select Sector SPDRs, the technology and utilities funds, have shown lower correlations to SPY over the past six months.

EDIV also makes a credible valuation argument with a P/E ratio of 9.63 and a price-to-book ratio of 1.35. EEM's P/E ratio is 17.34 and its price-to-book ratio is 3.01, according to iShares data.

With superior GDP and dividend growth rates compared to the developed world, a sturdy case can be made for adding emerging markets dividend payers to investors' portfolios. Those factors bolster the case for EDIV, but the ETF's ability to challenge larger rivals potentially hinges on perception. Going forward, will investors view EDIV as a low-beta yield play or as a risk because of the yield-weighting methodology and its tendency to trade at premiums to NAV?

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