High Income, Low Volatility Emerging Markets

By Matthew McCall | November 30, 2011 AAA

It has been extremely difficult for all types of investors over the last few months, as volatility remains high with huge daily swings. With the CBOE Volatility Index (VIX) trading at elevated levels, it appears the volatility is here to stay for the foreseeable future.
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Investors are now searching for stocks and ETFs that can offer exposure to the market when it moves higher, but at the same time does not experience the same high levels of volatility. More specifically, investors should be looking at the emerging markets based on the sell-off they have endured and the above-average growth prospects for the future.

Low Volatility with High Income
The EG Shares Low Volatility Emerging Markets Dividend ETF (ARCA:HILO) is a fund composed of 30 emerging market stocks that provide higher income and lower beta than the MSCI Emerging Markets Index. The ETF is fairly diversified with approximately 15% in the three top countries: South Africa, China and Thailand. The top sector is telecommunications, making up about 27% of the allocation; electric utilities accounts for about 13%.

The current dividend yield on the index is 6.73% and the net expense ratio is 0.85%. The ETF began trading on August 4, 2011 and since that time the ETF has lost 8.6% versus a loss of 17% for the iShares MSCI Emerging Markets Index ETF (ARCA:EEM) year to date. The combination of a higher dividend yield and less volatility makes HILO a clear choice when looking to gain exposure to the emerging markets. (For related reading on ETFs, see Using ETFs To Build A Cost-Effective Portfolio.)

The Stocks
For investors looking to buy individual stocks, we can take a look at the top holdings of HILO for ideas that follow the same principal as the ETF. The number three holding is Philippine Long Distance Telephone (NYSE:PHI), making up 5% of the portfolio. The company provides a variety of telecom services to the nation of the Philippines. The stock pays a 5% dividend and has a forward P/E ratio of 11.3. For the last few years the stock has been trading in a narrow range, thus the low beta, and is currently less than 10% from a new 52-week high.

Another telecom is a top holding in the ETF, this is due to their propensity of high dividends and low volatility. Telefonica Brazil (NYSE:VIV) provides fixed-line telecom services, broadband, and pay television services to customers in the state of Sao Paulo in Brazil. The dividend yield is about 12% and it trades with a P/E ratio of 10. The stock hit a multi-year high in June and has since drifted lower, giving value investors and opportunity to buy.

Centrais Electrais Brasileiras (NYSE:EBR) has not held up as well as the first two stocks and hit an all-time low earlier this year. The company, based in Brazil, is engaged in electric power generation and transmission. The stock is trying to form a bottom at the $8.25 area and could be a value play based on a forward P/E ratio of 12.6 and a PEG ratio of 0.82. (Learn how this simple calculation can help you determine a stock's earnings potential. For more, see PEG Ratio Nails Down Value Stocks.)

The Bottom Line
Keep in mind that during a bull market the value stocks with low beta will typically underperform, so there is a downside to this strategy. That being said, in a down market they should outperform and in a sideways market there is the large yield to help with minimal gains/losses.

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At the time of writing, Matthew McCall did not own shares in any of the companies mentioned in this article.

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