DVYE: You Should Not Own This ETF For The Long Term

ETF Overview

iShares Emerging Markets Dividend ETF (NYSEARCA:DVYE) owns a portfolio of relatively high-yielding dividend stocks in the emerging markets. Although the fund currently offers a 9.2%-yielding dividend, it has not delivered a positive total return since its inception in 2012. The fund's focus on high-yielding dividend stocks may result in stocks with lower growth potential or companies that are more vulnerable in economic downturns. Hence, DVYE should not be a long-term holding in your portfolio. Given a recession may not be too far away from now, there are tremendous macroeconomic uncertainties. The unfriendly Federal Reserve policy in the near term will likely also put pressure on DVYE's valuation. Therefore, investors should not own this fund right now.

Fund Analysis

An abysmal record of return since its inception

DVYE has performed poorly in this bear market that we are currently in right now. In fact, the fund shares have lost about 36% of its price in 2022. Even if we include its dividends, the loss was still nearly 30%. The fund performance was not much better, even if investors hold this fund for the long term. Since its inception in February 2012, the fund delivered a total loss of 17.52%. This was quite a contrast to other emerging markets ETFs that still delivered positive returns. As can be seen from the chart below, WisdomTree Emerging Markets High Dividend ETF (DEM) and Vanguard FTSE Emerging Markets ETF (VWO) delivered total positive returns of 9.25% and 22.14% respectively since 2012.

You should not evaluate a fund solely on yield, but focus on dividend growth potential

We think investors should not solely focus on DVYE's attractive yield, which currently stands at 9.2% and overlook the risk and the weaker long-term growth potential of stocks in its portfolio. While DVYE selects high dividend stocks in its portfolio by ensuring that they meet certain screening and buffering criteria, this construction method will not necessarily translate into high total returns in the long-term. Instead, we think a successful portfolio of dividend stocks should not solely concentrate on high dividend yields, but to focus instead on selecting dividend stocks with growth potential. If a company can grow its dividend over time, it usually means that their businesses are growing, and they generate excessive cash flow and therefore can afford to pay a growing dividend to their shareholders. Therefore, we think the better choice is to build a portfolio by including stocks with dividend growth potentials instead.

To solely concentrate on high-yielding dividend stocks will not be beneficial for several reasons. First, high yield stocks may be a result of their higher payout ratios. Therefore, the company is returning cash to its shareholders through higher dividends but are not retaining the cash to invest in the future growth or to repay their debts. In other words, future growth may be somewhat limited, and debt burdens may remain high. Second, higher yield usually comes with higher risks. Perhaps, the market is anticipating that the company may be facing some troubles ahead such as a potential dividend cut coming or the company may be running into some financial difficulties. Therefore, a portfolio construction methodology based solely on higher dividend yields may result in a lower quality portfolio.

We are not very far away from a recession

When investing in DVYE, investors should consider what stage of the economy we are currently in. We believe the global economy is currently descending from the peak of the economic expansion cycle towards a recession. During the peak of the economic cycle, cyclical sectors or rate sensitive sectors such as financials, energy, industrial, materials, and real estate sectors typically performs quite well. However, as soon as the economy reverses into a recession, these sectors will underperform. Unfortunately, these cyclical and rate sensitive sectors represent nearly 71% of DVYE's portfolio. Hence, there may be substantial downside risk in 2023.

Elevated treasury rate will continue to weigh on DVYE

Although central banks in emerging markets can set their own monetary policies, the reality is that Federal Reserve's monetary policy has a lot of influence on these emerging markets. As can be seen from the chart below, DVYE's fund price has an inverse correlation with the U.S. treasury rate, which is impacted by the expectation of how the Fed fund rate will move. When the Federal Reserve eases its monetary policy, it tends to cause fund flow from the United States to emerging markets. On the contrary, when the Federal Reserve tightens its monetary policy, money tend to flow from these emerging markets back to the United States. Therefore, equities in these markets tend to drop, especially if the Federal Reserve raises the rate aggressively. This was certainly the case last year. As the chart below shows, last year's aggressive rate hikes by the Federal Reserve has caused a sharp decline of DVYE's fund price.

Looking forward, we think persistent inflation will force the Federal Reserve to keep its rate elevated for longer. It is also very likely that the Federal Reserve will continue its rate hike path in the next few meetings, albeit at a slower pace than last year due to unpleasant inflation data in the past few weeks. If the Federal Reserve has to keep its rate elevated for longer, it will continue to suppress DVYE's fund price. Not only that, higher rates also usually means higher borrowing costs. Since DVYE's portfolio includes high dividend stocks that may have higher payout ratios or are already facing some challenges of their own, some of them may run into trouble, especially if they have a leveraged balance sheet.

Investor Takeaway

Based on our analysis, this fund should not be a long-term holding in one's portfolio, as it has a weak long-term growth prospect. For investors wanting some exposure in the emerging markets, there are better alternatives such as VWO that owns better quality dividend stocks albeit at lower yield. We do not recommend investors to own this fund right now, especially during this macroeconomic uncertainties in 2023.