Avoiding Chinese Tech? Try Emerging Market Small Caps

While large cap Chinese internet and technology stocks still hold plenty of promise, these are perilous times to be engaged with that group of assets.

Beijing’s regulatory crackdown on large- and mega-cap internet companies in the world’s second-largest economy is wiping hundreds of billions of dollars in market capitalization off the group and goes a long way toward explaining why the MSCI China Index is off almost 27% from its 52-week high.

Fortunately, there are avenues for investors that want to remain engaged with developing economies while skirting China big tech exposure. Enter the WisdomTree Emerging Markets SmallCap Dividend Fund (NYSEArca: DGS).

As its name implies, the $2.2 billion DGS combines dividends and small caps – a concept that’s often hard to come by, even with domestic equities. On that note, DGS sports a tempting distribution yield of 5.55%, which is well in excess of what’s found on domestic small cap benchmarks.

However, what makes DGS appealing today is its China exposure, or perhaps its lack thereof. The fund devotes just 12.66% of its weight to Chinese stocks, which is far below the typical weight assigned to that country in traditional large cap emerging markets indexes. DGS benefits don’t end there.

“The sector exposures one gets in DGS are also more tilted to cyclical sectors like Industrials and Materials and away from technology and communication services—further helping diversify portfolios in EM,” said WisdomTree Global Head of Research Jeremy Schwartz in a recent note.

DGS is home to roughly 750 stocks, providing investors with a broader basket than many U.S.-focused small cap ETFs. Additionally, investors can grab these perks at multiples that imply significant discounts to smaller domestic equities.

“DGS focuses on dividend-paying stocks—with a rigorous, valuation-based rebalance discipline. When we look at price-to-earnings ratios on estimated forward-looking earnings, we see P/E ratios in single digits at only 9.1x—whereas the broad MSCI EM Index is at 14.5x,” adds Schwartz.

Then there is the quality element, which is implicit with the DGS focus on dividends. Non-dividend payers in the MSCI Emerging Markets Small Cap Index, which comprise a decent percentage of that benchmark, have a lengthy history of lagging that benchmark.

That’s one point in favor of DGS. Another is lower volatility. Over the past three years, the annualized volatility on the WisdomTree ETF is 21.8%, according to ETF Replay data. That’s below the comparable metric on the domestic Russell 2000 Index as well as the large cap MSCI Emerging Markets Index.

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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.