DGS: High-Yielding EM Fund Investing In Dividend Paying Small-Cap Stocks

~ by Snehasish Chaudhuri, MBA (Finance).

WisdomTree Emerging Markets SmallCap Dividend Fund ETF (NYSEARCA:DGS) is an exchange-traded fund ("ETF") that invests in dividend-paying stocks of companies from diversified sectors that are listed in the emerging markets around the globe. DGS has an expense ratio of 0.7 percent and an asset under management of $2.58 billion. The fund pays quarterly dividends and generates above-average yield. During the period 2016 to 2021, DGS generated an annual average total return of almost 12.5 percent. Weighted average price to earnings (P/E) ratio of 7.7 percent suggests that DGS has been able to pick relatively undervalued stocks. The fund is priced around $20 and is trading at a marginal discount of 0.74 percent to its NAV.

DGS Benchmarks Itself with a Weighted Index Composed of Small-Cap Stocks

WisdomTree Emerging Markets SmallCap Dividend Fund was launched on 30th October, 2007 by WisdomTree Investments, Inc. The fund is co-managed by Mellon Investments Corporation and WisdomTree Asset Management, Inc. It invests primarily in growth and value stocks of small-cap companies. Small-cap stocks are very much preferred in emerging markets, but at the same time these holdings are riskier than their large-cap and mid-cap peers.

DGS benchmarks its performance against that of WisdomTree Emerging Markets SmallCap Dividend Index and uses representative sampling techniques to create its portfolio. The index is a weighted index composed of small-caps selected from the WisdomTree Emerging Markets Dividend Index.

The index first selects applicable securities meeting a basic set of criteria, centered on size, liquidity, location, etc. Stocks are then ranked on their dividend growth, pay-out and price momentum, and then the lower ranked stocks or equities with negative momentum are excluded from the index. Applicable companies ranking in the top 30 percent of highest yielding stocks are then included in the index. Being a dividend-weighted index, stocks that generate higher pay-outs are assigned higher weightage. Although the process of stock selection is a bit complicated, it seems quite reasonable.

DGS Invests Primarily in Large EM Economies with High Growth Potentials

WisdomTree Emerging Markets SmallCap Dividend Fund targets large emerging market economies with high growth potential. At present, the fund is yielding at 5.1 percent. Almost 80 percent of its assets are invested in six countries - Taiwan, China, South Korea, Brazil, India and Mexico. All these countries are expected to have a trillion dollar economy by 2027, expected to grow in excess of 4 percent CAGR, and have a credit rating of at least BB-. These economies are also far away from any major geo-political risk unless a war breaks out between China & Taiwan. The fund also has a decent turnover ratio of 45 percent, suggesting that DGS is quite steady with its investments.

DGS Invests in Selective Sectors within Each Selected Emerging Markets

More than 75 percent of investments are made in five sectors - financial services, information and communication technology (ICT), industrial, basic materials and real estate. Chinese, Taiwanese, and Indian economies are some of the biggest beneficiaries of the growth of the technology sector. South Korean and Taiwanese businesses are some of the leading players in the electronics and industrial sectors. Brazil and Mexico house some of the world’s largest material mining companies. And being among the largest and fastest growing emerging markets, the real estate and financial sectors are reaping up the gains as these economies attract more and more investments.

Composition and Performance of DGS’s Major Investments in Six Major EMs

Investments in the information technology (ICT) sector were made mostly in Taiwanese companies. Top investments in Taiwanese market included Wistron Corporation, Acer Incorporated (OTC:ACEYY), King Yuan Electronics Co., Ltd (KYEC), Powertech Technology Inc, Synnex Technology International Corporation (OTC:SYXTF), Chicony Electronics Co., Ltd., GIGA-BYTE Technology Co., Ltd., Macronix International Co., Ltd. (MCIX), WPG Holdings Limited, Inventec Corporation, Highwealth Construction Corp and Qisda Corporation.

Top investments in the Chinese and South Korean market included Bank of Guiyang Co Ltd, China Galaxy Securities Co., Ltd. (OTC:CGXYF), TangShan Port Group Co Ltd, China Minsheng Banking Corp., Ltd. (OTCPK:CGMBF), China South Publishing & Media, Sinopharm Group Co. Ltd. (OTCPK:SHTDF), China Railway Group Limited (OTCPK:CRWOF), Haitong Securities Co., Ltd. (OTCPK:HAITY), China International Marine Containers Co, China Cinda Asset Management Co., Ltd. (OTCPK:CCGDF), GS Holdings Corp, BS Financial Group Inc and Kumho Petrochemical Co Ltd.

Major investments in Brazilian and Mexican markets included Banco Del Bajio, S.A., Transmissora Alianca de Energia Eletrica SA, Kimberly-Clark de México, S. A. B. de C. V. (OTCPK:KCDMF), Grupo Aeroportuario del Centro Norte, S.A.B. de C.V. (OMAB), Energisa SA and Energias Do Brasil Sa (OTC:EGDBF). All these stocks had a relatively decent strong price performance during the past six months. As a result of this, WisdomTree Emerging Markets SmallCap Dividend Fund has been able to generate a total return of 13.08 percent, which is almost 45 percent higher than that of the S&P 500. Over the past three years, DGS’s annual average total return was almost equal to that of S&P 500, which stood at 14 percent. Since 2020, DGS has generated an average yield of 4.5 percent.

Investment Thesis

WisdomTree Emerging Markets SmallCap Dividend Fund generates an above-average yield. Despite investing in small-cap stocks, this fund possesses quite a high asset base. DGS is currently trading around $20, which is at par with its net asset value. The core portfolio of DGS also had a satisfactory price performance during the past six months. Average annual total return of this EM (emerging markets) fund also is quite high. Its portfolio is composed of stocks from the financial and real estate sectors in China and South Korea, from the ICT sector in Taiwan, and from materials businesses from Brazil and Mexico. However, the lack of diversification into healthcare, consumer staples, energy, utilities, etc. makes this fund a little riskier. Also, despite being an emerging market fund, it is highly concentrated only on the large economies.

Going forward, the economic growth of China, Taiwan, India, Brazil, Mexico and South Korea will be the prime driver behind the growth of DGS. These economies are having strong growth potential in the long run, and as long as they grow, the underlying sectors are going to reap benefits.

Based on these assumptions, I expect WisdomTree Emerging Markets SmallCap Dividend Fund ETF to sustain its current level of yield and also to generate steady capital gains over the long run. The fund, however, seems to be risky due to its investment niche of small-cap stocks. Default risk of DGS is relatively low, though, due to its investments in established companies from nations that have relatively safe ratings on their sovereign bonds. The WisdomTree Emerging Markets SmallCap Dividend Fund ETF investment strategy is most likely to suit long-term investors, especially considering the current market situation. WisdomTree Emerging Markets SmallCap Dividend Fund thus becomes a good investment option over a longer time horizon.

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