Despite market concerns over the fiscal cliff, dividend exchange traded funds still have a place in a typical income-oriented investment portfolio. With access to ETFs, advisors have the opportunity to also branch out of U.S. dividend-paying stocks and into the international markets, particularly emerging economies.

Dividend sectors such as utilities took a hit late in the year on expectations dividend tax rates will rise in 2013. The deal reached by Congress this week on the Bush-era tax cuts left dividend tax rates the same except for high earners -- singles with $400,000 or more in income and couples with $450,000 or more -- who will now pay 20 percent.

Investors won’t feel the tax hit when holding dividend investments in a tax-deferred retirement account – about 40 percent of the $5 trillion in IRAs are invested in equities. With the short-term pullback in dividend stocks as a knee-jerk reaction to the tax hikes, the tax-insensitive investors would be more motivated to jump at dividend-paying stocks on the cheap.

Furthermore, the question of dividends and tax hikes is not a new concept. Under President Clinton, the highest dividend tax rate rose from 31 percent to 39.6 percent in 1993. In the following decade, high-yield stocks still saw total returns in the highest tax bracket at over 11 percent, according to WisdomTree. Meanwhile, under President Bush, dividend tax rates were at their lowest ever, but both broad and high-yield stocks experienced much lower equity returns – broad market stocks saw total returns of 7 percent while high-yield stocks experienced total returns of 6 percent.

Going back to the period between 1943 to 1963, investors had to pay dividend tax rates as high as 91 percent but they still experienced some of the best long-term returns. According to WisdomTree data, both broad and high-yield stocks generated total returns of close to 10 percent.

When looking at equities, stable dividends provide that extra assurance in a stock’s value and returns.  With a steady payout scheme, investors are reassured in knowing that upper management is keen on raising shareholder value. Moreover, if history is any indication, dividends will continue to be the largest contributors to total return over the long term.

Most advisors and investors have been focused on U.S. dividend picks, but ETFs provide investors with the opportunity to branch out. Overseas, the emerging markets has provided investors with robust returns as the economies quickly expand. Investors have also enjoyed attractive dividend yields from emerging market stocks as well. Specifically, about 70 percent of global dividends come from companies outside of the U.S., so those who focus solely on the domestic market stand to lose out on a bigger dividend opportunity.

In addition, emerging market dividends will not experience the similar short-term pullback as associated with the fiscal cliff in the U.S. since these stocks are largely held by investors who are not impacted by U.S. tax laws.

Emerging Market Dividend ETF Options
The WisdomTree Emerging Markets High-Yielding Equity Fund (DEM) is the largest emerging market dividend-focused ETF that weights individual components based on cash dividends paid. Consequently, the ETF leans toward large-value companies. The ETF is also tilted toward the financials sector at 27.0 percent, followed by materials at 18.6 percent and energy at 18.4 percent. Top country allocations include Taiwan 20 percent, China 15.7 percent, Russia 13.1 percent and Brazil 12.5 percent. The fund is also a little bit top heavy as its top ten holdings make up about one-third of the overall portfolio. DEM comes with a 4.04 percent 30-day SEC yield.

Unlike DEM, SPDR S&P Emerging Markets Dividend ETF (EDIV) holds about 100 high-dividend-yielding emerging market companies and weights the components based on dividend yield, not to be confused with total cash dividends paid. To be included in EDIV, stocks have to have a total market cap of over $1 billion, with a float-adjusted market cap of over $300 million and a three-month average daily trading value of $1 million. The ETF’s top sectors include financials 22.5 percent, materials 20.6 percent, and telecom services 17.4 percent. EDIV takes on a heavier weighting in other countries from DEM, which include Brazil 19 percent, Taiwan 14 percent, Turkey 10.2 percent and Poland 10.1 percent. EDIV has a 6.69 percent 30-day SEC yield.

The iShares Emerging Markets Dividend Index Fund (DVYE) also weights its holdings based on dividend yields.
Components have to pass through a range of screens to be included in the ETF, including a dividend history, float-adjusted market cap, 12-month EPS, indicated annual dividend yield and three-month daily average trading volume. The fund’s top sector is financials at 18.2%, followed by utilities 17.3% and basic materials 17.2%. Top country allocations are Taiwan 22.2%, Brazil 17.8% and South Africa 9.2%. DVYE has a 5.37% 30-day SEC yield.

The EGShares Low Volatility Emerging Markets Dividend ETF (HILO) also provides an interesting alternative, especially with the growing interest in “low-volatility” styled investment strategies. The ETF is designed to generate higher income with less volatility than the MSCI Emerging Markets Index through low-beta stocks. The financials sector is the largest weighting at 20.8 percent, followed by consumer staples 17.8 percent and telecoms 16.6 percent. Top countries include South Africa 21.4 percent, Turkey 16.1 percent and India 11.4 percent. HILO has a 3.05 percent yield.

The next time you’re looking around for a dividend investment pick, try diversifying with an emerging market dividend ETF that could help provide attractive income opportunities as well as capture the growth story of the emerging markets.