The Allure of 10% Yield: Unveiling the Hidden Risks in High Yield Investments
High Yield Spotlight: A Classic Case Of Why You Shouldn’t Get Too Drawn Into A 10% Yield
Summary
The financial markets have been a roller coaster since the start of the Fed rate hiking cycle 5 quarters ago.
One group that hasn’t really participated in any of those environments is emerging markets.
The iShares Emerging Market Dividend ETF (DVYE), for example, trades at just 6 times earnings and yields more than 10%.
Every week, we’ll profile a high yield investment fund that typically offers an annualized distribution of 6% or more. With the S&P 500 yielding less than 2%, many investors find it difficult to achieve the portfolio income necessary to meet their needs and goals. This report is designed to help address those concerns.
The financial markets have been a roller coaster since the start of the Fed rate hiking cycle 5 quarters ago. In 2022, value and dividend stocks outperformed by a wide margin. The beginning of 2023 reverted back to leadership in tech and growth. The past 2-3 months has just been a lot of volatility without much direction. One group that hasn’t really participated in any of those environments is emerging markets. Sure, it had its moments, but EM turned out to again be what it’s been over most of the past 15 years - dead money. While the group will almost certainly have its moment in the sun again, it’s been a fool’s errand to try to guess when it’ll finally happen.
That doesn’t mean we can’t judge the group on its fundamentals. If you’re a value investor, you have to like what you see to at least some degree. Broad emerging markets trade at about 11 times earnings. If you want to dive deeper into just the dividend-paying stocks, valuations are even cheaper. The iShares Emerging Market Dividend ETF (DVYE), for example, trades at just 6 times earnings and yields more than 10%. Those numbers, in a vacuum, are incredibly attractive, but not if EM is going to remain out of favor and vulnerable to further losses. It’s time to take a deeper look into this group to see if there is some real value here.
Fund Background
DVYE tracks the Dow Jones Emerging Markets Select Index, which is composed of relatively high paying dividend equities in emerging markets. In addition to liquidity screens, stocks must have a non-negative trailing 12-month earnings-per-share, paid dividends in each of the previous three years and a minimum $250 million market cap. Qualifying components are ranked in descending order by dividend yield with the top 100 names making the final cut.
The modest balance sheet quality screens are a nice addition to the fund’s selection criteria, but let’s face it. This is a pretty straight high yield fund. No exclusions are made for any sectors, such as real estate, which may add some variability to performance. Even though the negative earnings screen is helpful, it ignores stock price action, which can result in artificially high yields that may be at risk even though earnings are positive. There’s no good way to screen out all of the “at-risk” stocks, but eliminating, say, the top 10% of yields from the portfolio, as some other funds do, could help cut out some of the potential outliers. Regardless, it’s good this isn’t a pure high yield play, especially when dealing with emerging markets.
Emerging markets are generally more dependent and financials and industry/manufacturing, so it’s not surprising to see a portfolio that tilts heavily towards cyclicals.
The fund overall is actually fairly diversified with six different sectors accounting for at least 9% of assets. The Asian region provides a large part of the fund’s tech exposure, but the heavy exposure to agriculture and commodities shows up in many places. Emerging markets tend to perform better in expanding economic conditions, which is evident when looking at the cyclical exposure here. DVYE likely will as well, although the cash-rich nature of dividend payers should help offset at least a bit of that cyclical risk.
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