For a Steady Stream of Cash

 | Apr 16, 2012 | 11:00 AM EDT  | Comments
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ELD

Over the last several months there has been a great deal of attention paid to dividends, from Apple's (AAPL) long-awaited announcement of a payout to the various ETFs that target dividend-paying stocks from the U.S. and elsewhere. Dividend-focused strategies have, of course, been around for decades. But the attention they've been getting this year and last is truly remarkable.

I understand the interest in payouts in the current environment. After all, cash flow is ultimately the driver of value for all investments, and dividends represent a way for investors to recoup their initial investment and earn a positive return on their capital. But I don't quite understand all the fuss over stocks that have dividend yields in the neighborhood of 2% to 3% when there are much, much better options out there.

One way of accessing such options is the WisdomTree Emerging Markets Local Debt Fund (ELD), an ETF that I've owned since it launched and that now makes up a significant portion of my bond allocation. ELD is a pretty straightforward product, yet it still represents an asset class that many investors choose to overlook: debt of emerging-markets issuers

 Despite the fact that the developing economies of the world find themselves on far more stable fiscal footing than the advanced markets in North America and Western Europe, a perception remains that debt of issuers is risky in Brazil, China, Malaysia and other emerging markets. This disconnect between investors' perceptions and the economic reality -- that is, it isn't all that risky -- creates an opportunity to capture superior risk adjusted returns. It's also an opportunity of which I'm more than happy to take advantage.

ELD has a 30-day SEC yield in the neighborhood of 4.6%, and the embedded income yield is north of 5%. That compares to a relatively paltry 30-day yield of 2.0% on iShares Barclays Aggregate Bond Fund (AGG), one of the most popular core holdings in fixed income portfolios. That's not a typo. Investment-grade U.S. bonds are really yielding 2%. That's basically a guaranteed way to erode the real value of your assets, since that figure won't come close to keeping up with actual inflation.

ELD is never going to shoot the lights out, and it's very unlikely to double in value over the course of a year or two. But I do believe this ETF offers a way to capture slow, steady gains that will only accelerate as emerging markets begin to raise interest rates. But there's another piece to the ELD puzzle that I find very intriguing: the opportunity to participate in the gradual appreciation of emerging-market currencies relative to the U.S. dollar.

There are a number of ETFs that offer exposure to emerging-market debt denominated in U.S. dollars, which removes the exchange-rate impact of owning assets denominated in anything besides the greenback. But I'm happy to take on the foreign currency exposure, even if it means higher volatility over the short term.

I view this source of risk (and of return) as the equivalent of the opportunity to generate capital appreciation in stock. Over the long haul, the currencies of emerging markets such as Brazil and India are going to appreciate relative to the dollar, and that increase in value will boost returns to ELD. In other words, I'm not willing to settle simply for the returns generated by interest payments, and the exposure to a basket of emerging market currencies means that I don't have to do so. 

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