Saturday, February 1, 2014

How do you solve a problem like Emerging?

That was fast - Emerging Markets went from everyone's darling to everyone's whipping boy. One of the main points of agreement for the last five years or so is that maybe the US would struggle, maybe Europe would struggle but Emerging Markets would be a good place to be. What happened?

I can sling some theories, but really I don't know. More to the point, it seems to me that the long term Emerging Market story, an emerging global middle class, is still in tact. Income investors will take dividend and growth from many places, and it makes sense to have diverse, global sources of income. Its surprisingly simple to construct a dividend portfolio where the sun never sets on your income stream.

All else equal, the preferred approach would be to simply screen for dividend payers in markets like China, India, Brazil, Turkey, Mexico and so on, and then try to find some steady Eddie's selling for bargain prices.

But all is not equal.

First off, the investor seeking global income will in most cases see their returns impeded by taxes. Deloitte has a handy reference on dividend taxation by country. According to Deloitte the tax rate imposed by country often means addtional tax burdens based on the country's policies, for example:

  • China 10%
  • Israel 20-25%
  • Turkey 15%

So this means if you are intrigued by, say Teva Pharmaceuticals, an Israeli company with global exposure. The Israeli government crimps your income from Teva's 2.5% forward yield. For most investors this takes a low but perhaps tolerable dividend to below market average. Over time those withholding rates will really take a toll. So why bother?

Some countries, particularly those where the British flag once flew, do not impose additional tax burdens. Companies domiciled in these areas offer a good opportunity at global income. China imposes a 10% tax burden on most dividends. However in Hong Kong there are listings of "Red Chip" companies with large operations in China, but listed in Hong Kong and the dividends should not be subject to foreign withholding. Red Chips include China Mobile, which has 767 million customers (not a typo) and a 4.2% dividend.

So when investing in other countries, its just as important to read up on tax and dividend withholding as it is to understand the business and its valuation. I will close out this section with a reminder that I am not a tax pro and you should always consult your tax pro to understand what any of these policies means to you.

Part of the basic idea of international investing is to choose stocks from a wider pool. What could be better than not limiting yourself to buying US stocks when the whole country only represents ~5% of the global population? Why not look to the whole world?

India's population is about 4 times the size of the US, around 1.2 Billion people, about 20% of the planet. Yet, there are only a small handful of Indian ADRs that trade on US markets.

Company Types
The emerging market story is tied to the burgeoning global middle class, but the reality is that consumer demand is pretty hard to access in many of these markets. Consider the Indian ADRs, you get access to companies like Wipro and Infosys which sell services to US/EU companies. You get access to mining companies. So while you are buying companies who are housed in emerging markets, their income is tied to the first world, sometimes quite directly.

You could punt and an ETF, but all of the above plays into your ETF selection as well. Many ETFs are sort of levered bets on first world economies. Targeting global income probably means looking for markets that do not impose additional dividend taxes and give access to companies that can weather storms rather than cyclical and levered commodity exposure.

Eliminating companies based on the above removes most companies from consideration. Where does all this lead then? Interestingly enough, right back to Lake Wobegon.

"Some luck lies in not getting what you thought you wanted but getting what you have, which once you have got it you may be smart enough to see is what you would have wanted had you known." - Garrison Keillor

The goals of an income investor seeking opportunities in Emerging Markets may in fact be best served by buying blue chips. To look at one examples here - Unilever(UL) gets 57% of its revenue in emerging markets and pays a 3.8% dividend. So in many cases its back to the blue chips for global exposure and an efficient total return.

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