Investors sifting through U.S. equities for dividends can obtain yields in the 3% range before needing to dip into riskier yields from the likes of MLPs and REITs. They haven’t gotten a lot of attention thanks to the bull market here in the U.S. that continues unabated, but there are some enticing yields of 4% or higher available overseas without getting too risky.
The iShares International Select Dividend ETF (IDV) is the largest international dividend-focused fund in the marketplace with assets of just over $4 billion. While the fund’s 30-day yield of 4.2% might gain investors’ immediate attention, it’s the fund’s focus on dividend quality that should intrigue them even more.
The fund uses the Dow Jones EPAC (Europe, Pacific, Asia and Canada) Select Dividend Index as its benchmark and, like many quality dividend ETFs, eliminates REITs from consideration right off the bat. From there, the fund applies the following screens for dividend quality…
- The company must have paid dividends in each of the past three years
- The company’s previous year dividend per share must be equal to or greater than the average dividend per share of the past three years
- The dividend coverage ratio must be greater than or equal to ⅔ of the corresponding country dividend coverage ratio
- A non-negative trailing 12 month earnings per share
- Market cap of at least $1 billion
- Average trading volume of at least $3 million
To summarize, the fund looks for companies that have a track record of paying and growing their dividends, are profitable and have the financial health to continue supporting dividend payments and are liquid. Once those screens are complete, the fund takes the 100 highest yielding stocks from the universe and weights them by yield.
It’s a sound investing strategy that has produced just one hiccup. Investors that got into the fund on day one would have enjoyed a return of next to nothing! There’s no doubt that the overseas markets haven’t enjoyed nearly the run that the U.S. market has, but that 0% return (0.6% average annual return if you want to be exact) can partially be attributed to timing too.
The fund’s launch in February 2007 came right before the financial crisis roiled markets all around the world. From inception through its lowest point in early 2009, the fund lost ⅔ of its total value. Since that point, however, the fund has returned more than 220%, the equivalent of a 15% average annual return. That’s still not as good as the 19% per year that the S&P 500 has delivered during the same time frame, but it paints a bit of a brighter picture of the fund’s potential once you remove that outlier period.
While the international markets still have to work through a fair number of issues (Brexit, potential government bankruptcies, etc.), there are signs of optimism. The Eurozone especially is looking stronger. Manufacturing expanded at the fastest pace in over five years. The retail sales reading for April jumped all the way up to 52.7, while GDP grew at a 1.7% year-over-year rate. The Chinese PMI number dipped to 51.2 in April but is still near multi-year highs, while Japanese PMI has shown seven consecutive months of expansion.
For those concerned about how expensive the U.S. market is, foreign equities look like a relative bargain right now. The International Select Dividend ETF’s portfolio sports a P/E or around 14 compared to the 18 multiple of the S&P 500. The fund’s P/B ratio of 1.7 is also about 40% lower than the U.S. benchmark. Concerned about higher risks from investing overseas? In a vacuum, the ETF is more risky but given its correlation with the S&P 500 at 0.8, a lot of that risk gets diversified away when combined with U.S. equities. In other words, add this fund to an existing dividend portfolio and you can add to your yield while limiting the addition of risk.
A couple of things to watch in this fund. A full ⅓ of the portfolio is invested in financials with another 12% in rate sensitive utilities. That’s putting a fair amount of weight on big banks and the future direction of rates. Also, half the portfolio is invested in the United Kingdom, Australia and France. The U.K. has been a popular spot for higher yields but is also working through the fallout of the Brexit proceedings. France could be headed towards a similar exit from the EU and will soon have a new president, so investors should be prepared for a significant degree of political risk.
But this fund is still a really nice option for dividend seekers. The portfolio is full of global giants with healthy balance sheets, strong cash flows and high dividends. Don’t be scared off by the fund’s meager since inception returns or underperformance to the S&P 500. The U.S. and international markets trade off market leadership positions over time and investors shouldn’t assume that the U.S. will continue its decade-long outperformance indefinitely. The International Select Dividend ETF does a solid job of balancing risks and returns while delivering historically above average yields.
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