How To Tilt Toward Quality In Emerging Markets

The quality factor has been in style this year. Fortunately for investors looking to expand their portfolios' geographic horizons, quality's advantages and utility are not limited to the confines of U.S. borders.

In fact, the quality factor is applicable to emerging markets equities and is accessible via the WisdomTree Emerging Markets Quality Dividend Growth Fund, WisdomTree Trust DGRE. A simple way of viewing DGRE is that it is the emerging markets equivalent to the popular WisdomTree U.S. Quality Dividend Growth Fund, WisdomTree Trust DGRW.

DGRE is a potentially notable idea right here, right now because of quality's advantages if and when U.S. interest rates rise.

Following The Fed

Assuming the Fed does proceed with raising interest rates, emerging markets investors should focus on quality over value. The MSCI Emerging Markets Quality Index outperformed its value counterpart and the MSCI Emerging Markets Index during each of the last three Fed tightening cycles.

“One of the more important questions in emerging markets that came to light after the U.S. presidential election saw interest rates, including the U.S. 10-Year Treasury note, rise dramatically, contributing to significant short-term U.S. dollar strength, is whether currencies, such as the Brazilian real, will snap back after a short-term correction or if they will trend back toward the weakness that was seen in the years immediately preceding 2016,” said WisdomTree in a recent note.

Emerging Markets

At the country level, the recent increases in country weights in DGRE represent opportunity and hedges on the recent election of Donald Trump as the 45th U.S. president. For example, DGRE's exposure to Mexican stocks increased 5.1 percent during the ETF's most recent rebalance while its weight to Russia rose by nearly 5 percent.

Taiwan, Brazil and South Africa, often staples of emerging markets dividend strategies, combine for about 40 percent of DGRE's weight. Investors are compensated for the risks that accompany DGRE's commodities exposure with a distribution yield of over 6 percent.

Notable is the fact that the annualized volatility of DGRE's underlying index is well below that of the MSCI Emerging Markets Index over the past three years. While Russia and Brazil surged earlier this year, these countries still offer the potential for upside.

“These countries were on fire during the first three quarters of 2016. What’s amazing is how much higher the return on equity or return on assets figures are within the WisdomTree Emerging Markets Quality Dividend Growth Index within each of these markets compared to the exposures within the MSCI Emerging Markets Index,” added WisdomTree.