Income investors are increasingly endangered by U.S. monetary policies that keep interest rates at zero and drive asset prices to nosebleed levels.
Thus, we need to look all over the world for assets that pay decent returns and aren’t too expensive.
Emerging market shares fit this bill.
And while they have their downsides, I’d argue that in today’s environment they represent a better risk-return balance than the shares of companies in the United States, Europe, or Japan.
The major advantage of emerging markets is that they tend to grow faster than developed markets. The International Monetary Fund projects that the real gross domestic product (GDP) of advanced economies will grow by 2% in 2015 and 2.2% in 2016, while emerging markets will see growth of 4% in 2015 and 4.5% in 2016.
And that’s during a period when many emerging markets have suffered badly from the price decline in commodities and energy.
At a price-to-earnings (P/E) ratio of about 20, you’re paying too much for too little growth in the United States and other advanced economies.
Meanwhile, in emerging markets you’re generally paying lower multiples and getting more growth.
Emerging Market Arbitrage
There’s one simple reason for this disparity: arbitrage between emerging market labor markets and those of the West.
Before 1800, there weren’t vast differences in wealth between different parts of the world. For example, medieval China was richer than medieval Europe.
However, the Industrial Revolution enabled Europe and the United States to gain immensely in wealth, while the primitive transportation and communication of those times prevented the wealth from spreading rapidly to the rest of the world.
Japan and the Far East caught up in the 1960s and 1970s, but the real revolution has come with modern telecommunications and the internet, which have enabled poor countries to join global supply chains.
This has caused a continual arbitrage between advanced country and emerging market wage rates, where the differential between the two tends to narrow over time.
The trend has also been exacerbated by foolish policies in the West.
Zero interest rates have narrowed the capital cost differential between rich and poor countries and encouraged investment in the latter, while the scourge of excess regulation has blighted rich economies.
Of course, emerging markets do have their disadvantages.
For starters, they tend to be less reliably run than Western countries – though in the past few years, the average emerging market’s fiscal and monetary policies have been sounder than most Western counterparts.
As far as political risks, they tend to balance out.
On the one hand you have an apparently well-run Malaysia that gets involved in a multi-billion dollar bribery scandal, as well as a resource-wealthy Venezuela that descends into a socialist dictatorship.
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On the other hand, there’s Argentina, which may suddenly be electing a sensible government after a decade of socialism.
Similarly, Colombia is making steady progress both economically and against its FARC guerilla problem.
Meanwhile, the silliness of many Western governments’ reactions to the 2008 financial crisis suggests the political risks are only moderately less in rich countries.
Take Your Pick
With faster growth, lower prices, and overall global trends favoring them, emerging markets should certainly be home for some of your money.
There are several exchange-traded funds (ETFs) specializing in emerging market dividend investments, any of which would be suitable for a U.S.-based income investor.
The WisdomTree Emerging Markets High-Dividend ETF (DEM) seeks to match the Wisdom Tree Emerging Markets High Dividend Index. It’s a $1.5 billion fund with a yield of 5.4% and a 0.64% expense ratio.
Next there’s the SPDR S&P Emerging Markets Dividend ETF (EDIV), a $298 million fund seeking to match the S&P Emerging Markets Dividend Index. It yields 5.3% and has an expense ratio of 0.59%.
Finally, there’s the iShares Emerging Market Dividend ETF (DVYE), a $158 million fund seeking to match the Dow Jones Emerging Markets Select Dividend Index. This one yields 6% and has a 0.68% expense ratio.
As you see, all three of these ETFs have higher yields than commonly found in developed country funds today, and they don’t suffer from the “eating your capital” problem of many domestic high-yield opportunities.
In today’s market, it’s madness not to consider them.