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With the fiscal cliff just a few weeks away and the two parties still at odds, the nervous investors are looking for assets that may provide refuge from the cliff. (3 ETFs to Prepare for the Fiscal Cliff)

A new report released by the White House yesterday warned that the fiscal cliff could “slow real GDP growth by 1.4% and limit consumer spending during the holiday season”.

Earlier this month the Congressional Budget Office said that the cliff would drive the U.S. economy back into recession next year and result in a jump in the jobless rate to 9.1% by the end of 2013.

Though the laws will change on January 1st, their actual impact will be felt over the course of next year. But the psychological impact of the changes is already visible as the businesses have curtailed investments and investors are selling stocks ahead of the potential capital gains tax hike.

While it is most likely that the two parties will reach some agreement, it remains to be seen what kind of changes they will agree to. They may agree to change the “threshold” for high-income or take away itemized deductions. It is possible that the dividend taxes may not go up for all the investors.

In anticipation of the increase in tax rate on dividends, many investors have been selling their dividend stocks. Some companies—particularly the ones with high insider ownership—are rushing to make accelerated or special dividends this year. (MLP ETFs: Unfortunate Victims of The Fiscal Cliff)

Currently the qualified dividends are taxed at 15% top rate, same as long-term capital gains rate. If the tax cuts are not extended, long-term capital gains tax will revert to 20% but the dividends will be taxed as income, at rates up to 39.6%.  Additionally, there will be a 3.8% surcharge on investment income for investors with higher incomes.

While high-quality dividend-paying stocks still represent long-term value, it is almost certain that these stocks will experience further sell-off if the tax laws become unfavorable. (Biotech ETFs: A Fiscal Cliff Safe Haven?)

For investors who are concerned about the “dividend-cliff”, an attractive option is to invest in the Emerging Markets Dividend ETFs that combine the opportunity to benefit from the higher growth potential in the emerging markets with the steady flow of dividend income in addition to providing the escape from the “fiscal-cliff” issues in the US.

Here are ten reasons for investing in Emerging Markets Dividend ETFs now:

1) The stocks held by these ETFs are not/will not be affected by the fiscal cliff issues, as these are mostly held by the investors who are not impacted by the U.S. tax laws.

2) About 70% of global dividends comes from the companies outside of the U.S. and hence by focusing just on the domestic companies, the investors are losing the bigger dividend opportunity.

3) Dividend payout ratios have been on a decline in the U.S. and the trend is expected to continue. Further, high corporate tax rates in the U.S. act as a disincentive to the large multinational corporations to repatriate their profits from international operations.

4) Emerging markets currently represent about one-third of global GDP and their share will continue to grow in the coming years. As such they ought to be a part of any investment portfolio.

5) The IMF projects that the emerging economies will grow at 5.6% in 2013, versus 1.5% growth for the developed economies and hence investment in emerging markets companies provides greater chances of  capital appreciation.

6) These markets have low correlations with the developed markets and thus provide diversification benefits to the portfolio.

7) The emerging markets companies often offer a higher rate of dividend yield compared with the domestic companies.

8) Some of the U.S. stocks/sector ETFs that are high dividend payers have become expensive compared with the broader market, as the yield-starved investors poured money into them in the last 2-3 years.

9) If the U.S. actually goes over the cliff, the economy would fall into a recession next year, whereas many other countries—especially the ones with a high level of domestic consumption--will continue to grow unaffected by the global headwinds.

10) The largest and most important emerging economy—China—finally seems to be bottoming out.

WisdomTree Emerging Markets Equity Income Fund (DEM - ETF report)

DEM tracks the WisdomTree Emerging Markets Equity Income Index, which is a fundamentally weighted index that measures the performance of the high dividend yielding stocks in emerging markets. The fund has currently has more than $4.5 billion in assets under management and charges 63 basis points annually for operating expenses.

The funds assigns heaviest weight to Financials (26.7%), followed by Energy (18.5%) and Materials (18.2%).

In terms of country allocations, Taiwan is at the top (20.5%), followed by China (15.6%), Russia (13.2%) and Brazil (11.9%). Its annual dividend yield is 3.64% versus average US dividend yield of less than 2%.

SPDR S&P Emerging Markets Dividend ETF (EDIV - ETF report)

EDIV tracks S&P Emerging Markets Dividend Opportunities Index, consisting of dividend paying securities of 100 publicly-traded companies in emerging markets. The ETF was launched in February last year and has so far attracted $321 million in assets.

Currently, it is heaviest weighted in financials (21.8%), followed by Materials (20.3%) and Telecom (18.1%). Country weights for the top three are Brazil (18.8%), Taiwan (14.1%), and Poland (10.0%).

The expense ratio for this fund is 0.59%, and it pays out a very attractive dividend yield of 6.01%.

Emerging Markets Dividend Index Fund (DVYE - ETF report)

This ETF introduced very recently (February 24, 2012), is designed to compete with the popular WisdomTree ETF mentioned above by providing a lower cost alternative to the investors, while fulfilling similar investment objective.

The fund seeks to replicate the Dow Jones Emerging Markets Select Dividend Index. This fund is less exposed to the Financials (14.6%) compared to DEM, with top weighting assigned to Industrials (17.7%) and Telecom (15.4%).

Taiwan leads the country allocation with 22.6% weight, followed South Africa (10.5%) and by Turkey (9.6%). The fund holds 101 stocks and thus focuses on a smaller group of companies compared with DEM (293 holdings).

The underlying stocks are selected on the basis of dividend yield. The ETF currently charges 0.49% to the investors. The adviser to the fund has agreed to waive a part of its management fee to limit the expense ratio at this level through the end of December 2014.

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