We conclude our four-post blog series of emerging market equity valuations with a focus on what has become a major theme for equity indexes, emerging market or otherwise: Low volatility. These “volatility-focused” indexes utilize different means for selecting and weighting constituent stocks with a goal of exhibiting lower volatility than do broad market benchmark indexes in different regions.
The Downside to Low Volatility: Potential Lack of Participation in Upside Moves
We believe that when people see the words “minimum volatility” or “low volatility” as part of an index name, they are reminded of their experience during the 2008–09 financial crisis and equate these terms with potential downside protection. Of course, downside protection is one potential effect of a volatility-focused approach, but another effect would be the potentially limited upside capture during a market rally.
Not to mention the thing that a volatility focus ignores completely: fundamentals. That’s not to say that one should focus 100% on potential volatility or 100% on fundamentals—the approaches are totally different, and at times this difference can provide a strong diversification benefit.
We often get asked how the WisdomTree Emerging Markets Equity Income Index (WTEMHY) compares to low-volatility indexes, given its beta of 0.8 since inception. Much of this low beta was a result of its performance in 2008 and 2011. But while the WTEMHY has displayed a low beta since its inception, it is not directly focused on volatility reduction. The methodology of the Index is primarily concerned with identifying the best valuation opportunities in the market, and those sectors can change across time. Currently, the best valuation opportunities can be found in the more cyclical sectors, while some of the lowest-volatility sectors have the richest valuations.
Below, we compare a variety of volatility – and dividend-focused indexes on both a valuation and volatility basis.
As we structure our analysis, we will first outline the indexes that we will be studying.
• MSCI Emerging Markets Index (MSCI EM)
• WisdomTree Emerging Markets Equity Income Index (WTEMHY)
• MSCI Emerging Markets Value Index (MSCI EM Value)
• WisdomTree Emerging Markets Dividend Growth Index (WTEMDG)
• MSCI Emerging Markets Growth Index (MSCI EM Growth)
• MSCI Emerging Markets Minimum Volatility Index (MSCI EM Min Vol)
• S&P BMI Emerging Markets Low Volatility Index (S&P EM Low Vol)
In essence, we will group WTEMHY and MSCI EM Value for their focus on value, albeit in different ways, and similarly we will group WTEMDG and MSCI EM Growth for their focus on growth.
Valuation Ratios for the Value and Growth Oriented Indexes
1Median price-to-earnings (P/E) ratio: P/E ratio of index constituents where 50% of constituent values fall above and 50% fall below.
2Beta relative to MSCI EM: Of the specified index, based on its 7/31/2013 constituents, relative to the MSCI Emerging Markets Index.
3Median long-term earnings growth expectations: Compilation of analyst estimates of the growth in operating earnings expected to occur over the company’s next full business cycle, typically three to five years. Value reflects the point where 50% of values are above and 50% are below.
4Median dividend yield: Value of the trailing 12-month dividend yield for a given index for which 50% of values are above and 50% are below.
5Median earnings yield: Earnings per share divided by share price. Value reflects the point where 50% of values are above and 50% are below.
6PEGY Ratio: Ratio of the median price-to-earnings (P/E) ratio divided by the sum of the median long-term earnings growth expectations and the median dividend yield. Lower numbers indicate lower prices relative to the median long-term earnings growth expectations and median dividend yield of the underlying stocks.
7Median dividend yield/median earnings yield: Meant to calculate the median payout ratio, which is the median dividend per share divided by the median earnings per share.
Next page: Interpreting the Data