Do Emerging Markets Fit in to a Dividend Portfolio?

Typically an investor who is investing in dividend paying stocks is more risk-adverse than an investor who looks primarily for growth stocks. Don’t get me wrong, a dividend based investment strategy can be risky (think Citigroup!), but a big reason investors choose dividend stocks is to mitigate a big portion of the risk that comes from investing in stocks. In the blogosphere, there has been some recent discussion of fitting emerging markets into a portfolio. As an investor, I have been giving this some thought over the past couple of weeks and would like to present my conclusions today.

From an investing perspective, emerging markets are areas in the world that are not fully developed, such as a United States or Canada. A definition from Investopedia provides us with insight into what an emerging market really is:

Emerging markets are considered relatively risky because they carry additional political, economic and currency risks. They certainly aren’t for those who value safety and security above all else. An investor in emerging markets should be willing to accept volatile returns – there is a chance for large profit at the risk of large losses.

An upside to emerging markets is that their performance is generally less correlated with developed markets. As such, they can play a role in diversifying a portfolio (and thus reducing overall risk).

The countries that are considered to be emerging depends on who you speak to. I decided to take a look at the Vanguard Emerging Markets Stock Index Fund to see what countries that fund thought were emerging markets. Here are the top five countries according to their data at October 31, 2007:

The obvious benefit that most investment advisers tout for investing in emerging markets is the potential for increased returns. However, as we know in the investing world increase returns often comes with increased risk. I came across an interesting chart from a company called Northern Trust that wrote an article about investing in emerging markets. The chart showed that having 30% of your global equity exposure in emerging markets (i.e. 70% of global exposure in non-US developed assets and 30% in emerging markets) provided almost 3% in additional return with no additional risk.

I have spoken in great length on this site about how portfolio performance is primarily a factor of asset allocation versus individual security selection. With that in mind, does it make sense that emerging markets be factored into a dividend portfolio as it would be providing exposure to a sub-asset class of equities that could potentially boost our returns? It could, as a small-percentage of an investor’s overall global asset allocation. As we see from the above graph, having too much emphasis on emerging markets an investor would open themselves up to a great deal more risk than one who just invests in larger more developed global markets. So what does that mean for my own portfolio?

In my own personal portfolio, I have a large component of my asset allocation allocated to global markets. In addition, I have added some more potential volatility to my portfolio with my recent purchase of a small-cap index fund. I beleive that adding more risk to my portfolio is not something that I need right now and will not be adding any emerging market exposure to my accounts. However, once I bring my global allocation to where it should be, I may consider adding a small-percentage to emerging markets through an index fund such as the iShares MSCI Emerging Markets (EEM).

Photo Credit: Vjeran Lisjak

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