This exchange-traded fund boasts a spiffy yield and should protect you in down markets. By Steven Goldberg, Contributing Columnist May 9, 2012 You usually don’t find the words “emerging markets” and “dividends” in the same sentence. You buy emerging markets stocks for growth, with dividends pretty much an afterthought. SEE ALSO: Our Special Report on How to Prosper in Emerging Markets Meet WisdomTree Emerging Markets Equity Income ETF (symbol (DEM). This exchange-traded fund focuses on emerging-markets stocks that share the wealth. WisdomTree ETFs differ from typical index funds. Conventional index funds use market value (share price times number of shares outstanding) to decide how much of each stock to buy. In contrast, WisdomTree weights companies based on the amount of dividends they pay out (dividends per share times number of shares outstanding). Advertisement So Taiwan Semiconductor, which has 25.9 billion shares outstanding and pays out 10 cents per share per year, is WisdomTree’s top holding. The company paid out $2.7 billion in dividends over the past 12 months, earning it a 3.5% weighting in the ETF. The fund is that simple. But its performance has been superb. From its inception in July 2007 through May 7, the ETF returned an annualized 5.6%. That’s an average of 5.9 percentage points per year better than the MSCI Emerging Markets index. The ETF currently yields 6.2%. Will such incredible performance continue? In bad markets -- with the notable exception of the 2007-09 bear market -- investors have flocked to stocks that pay healthy dividends. And emerging markets -- by definition more volatile than developed markets -- have suffered plenty of bad markets of late. Consider the numbers. During the 2007-09 disaster, Standard & Poor’s 500-stock index plunged 55.3%. But the MSCI Emerging Markets index was torpedoed for a 60.2% loss. On a relative basis, the WisdomTree ETF did much better, losing 47.0%. Advertisement What’s more, emerging markets suffered a second bear market last year. From May 2 through November 25, the MSCI index lost 25.9%, but the WisdomTree ETF lost only 22.5%. The ETF’s outperformance on the down side shouldn’t be surprising; it has been about 15% less volatile than the MSCI index. But dividends don’t always pay off. Jeremy Schwartz, research director at WisdomTree, says dividend-paying stocks thrive when value stocks outperform -- which hasn’t been the case in the U.S. since WisdomTree opened its doors. Since the launch of WisdomTree U.S. Equity Income ETF (DHS), the firm’s oldest fund, in 2006, the ETF has outperformed the Vanguard Value Index (VIVAX), an index mutual fund that invests in large, undervalued companies, by a mere 0.2 percentage point per year. The Vanguard index, in turn, has trailed the S&P 500 by an average of 1.8 points per year. Many of WisdomTree’s other domestic funds have lagged their benchmarks for the same reason, Schwartz says, primarily because their dividend strategy led them to hold a lot of financial stocks, which blew up during the 2007-09 bear market. WisdomTree’s foreign funds, in general, have done better than its domestic funds, and most have beaten their benchmarks. Schwartz says more companies outside the U.S. pay generous dividends. Consequently, the foreign ETFs held less in financial stocks. Advertisement WisdomTree’s emerging markets fund has been the standout. It’s the biggest of the company’s 48 ETFs, with $3.8 billion in assets. More than 90% of emerging markets stocks pay dividends; that compares with about 75% of U.S. companies. I think part of the fund’s success stems from the nature of dividends -- and part has to do with luck. I’ve been unable to identify a single good actively managed, no-load emerging markets stock fund. Managers in this category are bedeviled by lack of transparency in corporate reporting, high trading costs and corruption. My hunch is that when you put in a big buy order with a local brokerage in an emerging market, the broker, his or her family, and a dozen of their best friends often buy the stock before your order gets filled. With an index fund, even an arcane index fund such as WisdomTree’s, you don’t have that problem because index funds trade infrequently. More important, dividends -- unlike quarterly earnings reports -- don’t lie. When corporate managers in emerging markets pay dividends, they may also be saying something about their own ethics. Or, it could be that their families own a ton of the stock. Either way, the executives are on the same side as the shareholders. Look closely at the holdings of the WisdomTree ETF and you’ll find significant contrasts with the MSCI index. The ETF has 21% of its assets in Brazil (compared with 13% in the index), 22% in Taiwan (compared with 11%), 10% in South Africa (8%) and 9% in Malaysia (4%). On the other side of the coin, it has just 3% in China (19% in the MSCI index), 2% in Russia (7%) and nothing in India (6%). Advertisement Some of these big bets strike me as sensible. I wouldn’t invest a ruble in a Russian stock. To some extent, the ETF’s dividend strategies may push it toward more-honest markets. But good fortune is also at work here. The bottom line: Don’t buy this fund because you think it’ll keep beating the index by a ton. Buy it because you think it will do a bit better than the index and protect you more than a little in down markets. Steven T. Goldberg is an investment adviser in the Washington, D.C. area. 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