Not too many years ago, the words "dividends" and "emerging markets" seldom appeared together in the same sentence. If they did, you might have read, "Investors should not expect much in the way of dividends from companies in emerging markets."
Things have changed.
A study by Qing Li and Aye M. Soe published last month by S&P Dow Jones Indices notes that the percentage of dividend-paying companies in emerging markets has risen from about 60% in 1998 to between 70% and 80% in 2014. Over the same period, dividend payers in developed markets fluctuated between 60% and 70% of companies.
The study also observed that the aggregate annual payout ratio in emerging markets has been rising, while the percentage of earnings paid out to shareholders in developed markets has declined.
Why should you and your clients care? After all, even advisors who fully weight emerging markets in client portfolios will have only a small portion of assets in these countries.
But emerging markets are likely to play an important role in the future of investing, even for your clients seeking income.
In 1993 emerging markets represented only 0.6% of the weight of the S&P Global Broad Market Index (BMI), a rules-based, float-adjusted measure of world stock market performance. In 2014, however, emerging markets accounted for 9.7% of the index.
And McKinsey Global Institute estimates that 46% of Fortune Global 500 companies will be domiciled in emerging countries by 2025 -- up from only 5% in 2000.
Even though numerous studies have shown that dividend payers generally outperform nonpayers in developed markets, many investors still believe that a company paying a dividend has limited growth potential and that shares of dividend payers are almost always a "value trap."
PAYERS VS. NONPAYERS
To counter that impression in the emerging markets space, Li and Soe separated the S&P Emerging BMI into dividend payers and nonpayers.
From Dec. 31, 1998, through the end of 2014, the payers posted an average annual return of 15.79%, with a Sharpe ratio of 0.30 and a standard deviation of 12.60%. The nonpayers returned 3.52% annually and had a Sharpe ratio of 0.05 and a standard deviation of 15.79%.
To put a finer point on it, the authors divided emerging market dividend payers into quintiles by yield. The first quintile, those stocks with the highest yields, had the best average annual returns and the highest Sharpe ratios. As you go down in yield, each successive quintile shows a lower average annual return and a lower Sharpe ratio.
What's more, the top-yielding quintile showed the smallest peak-to-trough decline in down markets -- demonstrating that investors will hold on to stocks that will pay them again within a few months but are quick to sell nonpayers that don't rise in price.
The study also looked at the quality of dividend-paying emerging market stocks. Over the 16-year period, the payers had a higher average return on equity and a higher gross profit margin than nonpayers.
The payers also had lower debt-to-equity and debt-to-asset ratios.
There are several ETFs that focus on dividends in emerging markets. Currently, the three largest emerging markets dividend-focused ETFs (by total assets) are the SPDR S&P Emerging Markets Dividend ETF (EDIV), iShares Emerging Markets Dividend ETF (DVYE) and WisdomTree Emerging Markets Dividend Growth Fund (DGRE).
Although two others folded late in 2014, investors should expect more activity in this increasingly important area.
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