Investment Thesis
The iShares MSCI Emerging Markets Multifactor ETF (EMGF) tracks a “smart-beta” index of large- and mid-cap stocks in emerging or developing countries around the world such as China, India, South Africa, South Korea, and Russia. (Of course, it strikes me as a bit odd that South Korea and Russia would be counted among “emerging market” countries, but we’ll get to that below.) Crucially, the ETF’s stock-picking methodology relies on several style factors, which, when combined, are expected to achieve sustained outperformance over more plain, “vanilla” emerging market ETFs.
At a fund P/E ratio of 13x and price-to-book ratio of 1.5x, EMGF isn’t terribly expensive, especially compared to a broad-based ETF of large-cap American stocks. Compare this to the Vanguard FTSE Emerging Markets ETF (VWO) with a P/E ratio of 16.3x and price/book of 1.9x.
The ETF also has a fairly low beta of 0.87, meaning that it is less volatile than the S&P 500 (SPY). The expense ratio is modest at 0.45%, and the dividend yield (based on the previous two semi-annual dividends) is 2.55%.
But the biggest surprise of all, for me, was the ETF’s consistent and significant dividend growth over the past five years. Let’s explore EMGF and why it might make a strong long-term dividend growth investment, at the right price.
The Portfolio
The ETF is designed to pick stocks from the MSCI Emerging Markets Index based on what are called “style factors,” which are certain characteristics shared by broad swathes of equities. The four factors used by the ETF to pick and weight stocks are:
- Value
- Quality
- Momentum
- Relatively low size
Value refers to certain valuation metrics such as price-to-earnings, price-to-book ratio, and enterprise value to EBIT. Quality refers to stocks that score well in metrics like return on equity, return on assets, debt to assets, and earnings stability. Momentum refers to sustained upward price trajectory, especially relative to the underlying index. And low size basically just means that the ETF doesn’t weight purely based on market cap, though it still holds mostly large-cap names.
The ETF limits each industry to no more than 25% of the total portfolio. Information technology (i.e. tech and internet companies) brush right up against that upper bound and would likely exceed it if not for the rule.
Source: iShares EMGF Product Page
Personally, I like to see financials taking up a smaller part of the portfolio than your average EM fund. Many types of financial companies, including banks and insurance companies, will have a tougher time maintaining growth in a sustained low interest rate world. Granted, many EM countries have more room for rates to fall before going negative than more developed countries, but it will still be a headwind to financials in general.
Notice also that the ETF is light on the traditionally higher yielding industries of real estate, utilities, and energy. As is clear from the 2.55% dividend yield, the ETF is not a high-yield play. It’s a quality growth play. But as we’ll see in the Dividend section below, this correlates with faster dividend growth.
Now, one thing to note is that EMGF has significant exposure to China, both directly and indirectly through Taiwan, the stock performance of which tends to correlate closely with China.
Source: iShares EMGF Product Page
In fact, exposure to China and Taiwan in EMGF is even more than the 41% and 12.3% exposures, respectively, in the underlying MSCI Emerging Markets Index. That makes EMGF largely, though not entirely, a play on China.
We can see this in the fund’s top ten stocks, which are roughly representative of the overall allocation with six of the ten located in China or Taiwan:
Source: iShares EMGF Product Page
A fairly significant chunk of EMGF’s success in rebounding this year has been in its exposure to Alibaba (BABA), the Chinese e-commerce equivalent of Amazon (AMZN), as well as other information technology companies in China, India, Taiwan, and elsewhere. Just since April 1st, the four largest holdings have popped by around 80%.
Given that global tech companies have enjoyed a stronger run up in price this year than I think they deserve, it might be a good idea to wait for a more attractive entry point for this ETF.
The Dividend
The 30-day SEC yield currently sits at 2.16%, while the trailing twelve month dividend yield is 2.55%. The lower yield based on the most recent dividend payout is mostly because the dividend paid out in the first half of the year is typically smaller than the one paid out in December.
EMGF’s dividend, obviously paid in USD, could certainly fluctuate from year to year due to foreign exchange. For instance, the dividend paid out in June of this year is down about 9% from the same payout last year. The good news is that the relative strength and weakness of various currencies tend to balance out over time, as evidenced by EMGF’s consistent annual dividend growth over the last five years.
Here’s the annual dividend history for EMGF over the last 4.5 years (via Dividend Investor):
- 2016: $0.725
- 2017: $0.963 (+32.8% YoY)
- 2018: $1.056 (+9.7% YoY)
- 2019: $1.200 (+13.6% YoY)
- 2020 YTD: $0.409
Assuming a current dividend yield of 2.6% (based on a rough estimate of 2020’s full-year dividend payout) as well as an average dividend growth rate of 11%, buyers of EMGF at today’s price could expect a yield-on-cost of 7.4% after ten years.
If, however, the average dividend growth rate was only 10% per year, then the 10-year YoC would come in significantly under 7%. That makes the high dividend growth rate important, considering the low starting yield. If the starting yield rose to just 2.7%, then a 10% dividend growth rate would render a 7% 10-year YoC. A 3% starting yield would give average dividend growth of 9% per year a 7.1% 10-year YoC.
Clearly, a lot depends on one’s expectations for the future growth of the EM companies in this ETF.
Conclusion
For investors interested in a long-term dividend growth play on emerging markets (especially China), EMGF looks like a solid pick. The particular combination of factors in this smart-beta fund have produced impressive year-over-year dividend growth over the last five years, despite not being focused on dividends.
Personally, though I like the ETF as a dividend growth investment, I will wait for a more attractive starting yield of 2.7% or higher before putting funds to work in it.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
