The Best Way To Earn Income From Emerging Markets

It was the turn of the millennium when I boarded a train headed to a place that had just become its own country seven years before. I would be spending Y2K in the U.S. embassy overlooking the city of Prague in the Czech Republic.

#-ad_banner-#The country was young and not well known, but its growth potential would turn out to be tremendous. 

I spent time touring the incredible city. I walked over the Charles Bridge — the most important connection to Prague Castle and the city’s old town — and admired its architecture and history. 

The most impressive thing was the surprising lack of tourists. It was like I had the city all to myself. Most people still called it Czechoslovakia. At the time, Prague was Eastern Europe’s hidden gem. 

Fast-forward six years to when I returned… and it was a completely different city.

The Charles Bridge was completely packed, the line to enter Prague Castle was a 30-minute wait, and the locals now spoke German and English on top of their native tongue. Prague was no longer Eastern Europe’s secret. It had developed into a vibrant city booming with people from all over the world. The Czech Republic had officially reached developed country status in less than 13 years since it began in 1993. 

In the six short years between my visits to Prague, the Czech Republic’s GDP exploded from $58.8 billion in 2000 to $148.3 billion in 2006, peaking at $225.4 billion in 2008.

It’s the type of GDP growth that we all dream about when investing in emerging markets.

You see, investors are attracted to the potential growth of GDP in emerging-market countries as they expect it to drive strong equity returns. 

For instance, during the Czech Republic’s incredible six-year stretch of economic growth (from 2000 to 2006), the country’s stock index soared over 600%.  

This wasn’t an isolated instance. For instance, two of the Czech Republic’s European neighbors, Hungary and the Slovak Republic, also had booming GDPs that correlated with surging stock indices over the same time period: 

GDP Growth From 2000-2008

Now take a look at their respective indexes for the same period:

Stocks For Emerging Markets Soared As Their GDP Grew

As you can see, explosive GDP translated directly into each country’s stock exchange. When GDP grows, investors become more confident in that country, bringing a surge of foreign investment. 

In other words, explosive GDP growth can lead to exponential gains. 

For example, had you invested in the Prague stock exchange in 1999 and held until the Czech Republic reached its peak GDP, you would have booked a gain of just over 600%, compared with the S&P 500’s gain of 34% over the same period. And even though Czech stocks were hit hard during the financial crisis, you still would have gained 260% (compared with the S&P’s 95%) if you had held through to today:

The bottom line: Watching the GDP growth of emerging markets can be a great indicator as to how its stock market is going to perform.

  In the six short years between my visits to Prague, the Czech Republic’s GDP exploded from $58.8 billion in 2000 to $148.3 billion in 2006, peaking at $225.4 billion in 2008.  

And lucky for investors, emerging markets are expected to see especially large gains in GDP this year. In fact, the International Monetary Fund (IMF) estimates that emerging-market GDP growth will average almost 6% in 2014 — dwarfing the U.S.’ roughly 2% GDP growth in recent years. IMF even expects some areas, like developing Asia (countries like Indonesia, Thailand and Malaysia), to expand more than 7%.

After the U.S. market’s historic 30% rally in 2013 and with U.S. indices trading at all-time highs, U.S. stocks are starting to look expensive. Investors are beginning to look elsewhere, and the one place that’s especially ripe for growth is emerging markets. It may be just the right time to jump back in.

The iShares Emerging Markets Dividend ETF (NYSE: DVYE) provides the opportunity to capitalize on emerging markets (particularly in developing Asia). This exchange-traded fund invests primarily in small and mid-cap companies in emerging markets with particular exposure to greater Asia (countries like Taiwan and South Korea) and developing Asia. 

Currently yielding 4.65%, DVYE looks for some of the more established companies in emerging markets, paying special attention to companies that pay dividends. To be included in the ETF, companies must have paid dividends over the past three years, which helps weed out riskier companies. This strategy helps avoid the large price fluctuations often found when investing in emerging markets.

Risks to Consider: As with all investing opportunities, there is a considerable amount of risk associated when investing in emerging markets. When foreign investment floods a developing country, it often leads to political tension or currency risk. 

Action to Take –> For those investors looking to allocate a small portion of their portfolios toward emerging markets, DVYE provides a great opportunity to generate income while skirting some of the potential risks associated with those markets.

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