New Emerging-Market ETF Reaches for Yield

NEW YORK (TheStreet) -- Exchange-traded fund provider Emerging Global has been very active lately with new fund filings and launches.

Its newest fund is the EG Shares EM Dividend High Income ETF ( EMHD).

The underlying index starts with the stocks in the FTSE Emerging All Cap ex-Taiwan Universe and will equally weight the 50 highest-yielding stocks in the universe subject to a liquidity screening. The result is a reported yield for the underlying index of 8.8%. The fund will charge a 0.85% expense ratio, which could put the yield for the fund at a little bit less than 8%.

The "ex-Taiwan" is worth mentioning because some index providers do not consider Taiwan to be an emerging market. EG Shares' new funds have tracked indices that exclude Taiwan, suggesting the fund provider thinks that excluding Taiwan makes for a purer emerging-market product.

Like many EG Shares funds, EMHD is heavy in BRIC countries, with Brazil the largest at 20%, followed by South Africa at 17% and China at 14%. Turkey, which doesn't usually feature in broad-based funds, has a 13% weighting, and the biggest surprise is Pakistan, with an 8% weight.

The largest sectors are financials and utilities at 20% each. This only makes sense in a high-dividend fund because both sectors typically pay large dividends.

The last few months have been very challenging for emerging markets and interest rate-sensitive sectors that tend to pay higher dividends. The SPDR S&P Emerging Markets Dividend ETF ( EDIV) and its relatively high 6.8% trailing dividend yield may help set expectations for how EMHD might trade during challenging times.

At its low for the year, EDIV was down 20.9% compared to a 17.3% drop for the benchmark iShares MSCI Emerging Markets ETF ( EEM).

Similar to EMHD, the largest sectors in EDIV are financials and utilities, which make up 42% of the fund. Brazil has the same 20% weighting in EDIV, but otherwise the two funds have a different company makeup. EDIV has 13% in Taiwan and 9% in Poland compared to no exposure in EMHD.

The large exposure to Brazil could also be an ongoing source of volatility for both funds. A slowdown in China, real or perceived, has been a problem for Brazil because a lot of the economic and stock market success of the last few years came from China's demand for Brazil's natural resources.

Brazil has also had social unrest leading to protests about issues ranging from poor transportation infrastructure to inadequate health care. China's problems and the protests have contributed to the year-to-date 24% decline for the iShares MSCI Brazil ETF ( EWZ). The dividend funds will have a tough time going up without Brazil.

This year, emerging markets have performed poorly, culminating in something of a market panic in June. The utilities sector, which is heavy in both dividend funds, should be expected to struggle if rates go higher.

The U.S. market seems to have started pricing in the inevitability of rates moving toward a more normal level. The central banks in most emerging-market countries did not have to resort to zero percent rates or debt monetization, but there is the possibility that a reduction in quantitative easing will continue to pull assets from the emerging markets as investors will no longer have to go to exotic destinations for yield.

Whether that turns out to be correct on a fundamental basis, the panic in the U.S. in June did spill over into emerging-market, interest rate-sensitive assets. If interest rate panic in the U.S. continues to affect emerging markets going forward, then both EMHD and EDIV should be expected to struggle.

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

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