Dividend Growth Investing Comes to Emerging Markets

NEW YORK ( TheStreet) -- Investors in emerging-market equities have had a dreadful first half of 2013.

The iShares MSCI Emerging Market ETF ( EEM) is down 15% year to date, vs. a 13% gain for the SPDR S&P 500 ( SPY).

The performance dispersion has been shocking, and in the near term, the prospects for China and Brazil, both prominent countries in every broad-based emerging-markets fund, don't offer much encouragement.

China's financial house appears to not be in order, and there are protests in the streets of Brazil over inequality. For that matter, there is also protesting in Turkey and now Cairo.

All asset classes have their turn looking grim, and now is one of those times for emerging markets, but the space is not permanently broken. Long-term investors will still derive long-term benefits from investing in the space.

It is with an eye to the long term that ETF provider Emerging Global launched the EG Shares Emerging Market Dividend Growth ETF ( EMDG).

The word "growth" in the name of the fund refers to the extent to which all of the holdings have increased their dividends for the last five years at a faster rate than FTSE All Cap Emerging ex-Taiwan Universe.

It is unlikely that too many people have ever heard of an ex-Taiwan index, but it is an important distinction. Taiwan, along with Israel and South Korea, has occupied a sort of middle ground between developed and emerging markets. EG Shares prefers to exclude Taiwan from EMDG to capture a purer emerging-market exposure.

The country weights are capped at 20%, with China at 19.5% of the fund, followed by South Africa at 17%, Brazil at 15%, Indonesia at 11%, and some other countries with small allocations. South Africa has had its share of problems lately with the selloff in precious metals contributing to a 20% decline in the South African currency against the dollar.

The sector allocation also imposes a 20% cap. Financials are the largest sector at 20%, followed by oil and gas at 17%, consumer goods at 14% and utilities and telecom, which each make up 10% of the fund. The large weightings in financials and energy make sense for any emerging-market fund because most emerging-market countries have one or two large banks and a big oil company.

In addition to five years of accelerated dividend growth, companies in the fund must have a yield that exceeds 50% of the trailing yield for the market where the companies are listed.

If the yield for the home market index for a company is 3%, then the company must have a yield greater than 1.5%. Constituents must also have a five-year compound annual growth rate, or CAGR, for their dividends of 6%.

EMDG will have 50 equal-weighted holdings that will rebalance quarterly with the fund reconstituting annually starting next March. The expense ratio will be 0.85%, and EG Shares shows a current yield for the underlying index at 3.87%, which, after accounting for the fee, could put the fund's yield at 3%.

The EG Shares Web site offers research that makes a compelling case for investing in emerging markets via dividend growers as opposed to a market cap-weighted fund such as EEM.

But EMDG is still a proxy for emerging markets. If EEM goes down another 10% this summer, then EMDG will also go down, maybe more or maybe less, but it won't go up in the face of a broad decline. As EG Shares' research makes clear, if there is going to be a benefit from owning dividend growers it would most likely be realized over a period of years, not weeks.

At the time of publication, Nusbaum had no positions in securities mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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