Income-starved investors have been showing plenty of love lately for exchange-traded funds that focus on U.S. dividend stocks. According to Bloomberg data, three of the 10 exchange-traded funds (ETFs) with the strongest 2011 inflows--a combined $8.7 billion--focus on U.S. dividend stocks. With an average yield of 2.8 percent, it’s easy to see the attraction. A 10-year Treasury yields 2.0 percent these days.
If you’re diving for dividends only stateside, you’re missing out on plenty, says Jeremy Schwartz, director of research for the WisdomTree family of ETFs. Of $1 trillion in dividend payments made last year among the 4,000 global stocks tracked by WisdomTree, the U.S. accounted for just 25 percent of the total. The 19 international dividend ETFs tracked by Bloomberg have an average yield of just under 4 percent.
“International dividend stocks are an interesting place for a yield investor to be,” says Alec Young, global equity strategist at S&P Capital IQ. He notes that the combination of the Federal Reserve’s continued suppression of interest rates in the U.S. and stronger growth in some international regions (think: emerging markets) makes dividend investing abroad compelling for income seekers.
Here are some issues to consider if you want to tilt your portfolio toward the $750 billion in dividends being paid outside the U.S:
Check Your Funds. You may have more dividend exposure in existing holdings than you realize. The $6.6 billion Vanguard FTSE All-World ex-U.S. ETF (0.22 percent expense ratio), for example, has a 3.1 percent yield without specifically trawling for dividend payers. Todd Rosenbluth, ETF analyst for S&P IQ, notes that the ETF rates an “overweight” based on S&P IQ’s analysis of the relative value of the underlying issues in the portfolio. Nearly half the portfolio is invested in European companies and another 40 percent is in Asia. About 20 percent is invested in emerging markets.
If the Euro mess has you worrying about dividend stability among banks, you can find an ETF that strips them out. The WisdomTree International Dividend ex-Financials ETF (4.7 percent yield, 0.58 percent expense ratio) steers clear of the sector.
High Yield, Higher Volatility. Three of the largest international dividend ETFs are the SPDR S&P International Dividend (6.6 percent yield, 0.45 percent expense ratio), IShares Dow Jones International Select Dividend (5.0 percent yield, o.50 expense ratio) and PowerShares International Dividend Achievers (3.1 percent yield, 0.50 percent expense ratio). All three seek out the highest-yielding stocks within their chosen universe of dividend payers. Keep in mind that high yields can mean higher volatility. A struggling company with a low stock price will likely have a higher yield, since to get the yield you divide the annual cash payout by the stock price.
In the tumultuous third quarter of last year, the SPDR S&P International Dividend portfolio slid 23 percent, vs. a 19 percent decline for the MSCI EAFE index. Long-term investors have nonetheless fared well: The ETF’s 24 percent annualized gain over the past three years outpaces the 19 percent gain for the EAFE index. Tom Lydon of ETFTrends notes that the PowerShares ETF does provide some quality control because it only invests in stocks that have managed to increase their dividend for the past five years.
Consider Targeted Exposure. Your generic international dividend fund is likely to have a good shot of emerging markets exposure--all the ETFs mentioned above, save the one from Powershares, have about 19 percent of the portfolio in emerging markets. If you want to add a bigger scoop of emerging markets, Patricia Oey, who covers international ETFs at Morningstar, says focusing on dividend payers can be a risk-dampening way to fulfill your emerging markets allocation. “Paying a dividend signals better corporate governance,” she says. Schwartz of WisdomTree says average dividend growth in emerging markets was 13.6 percent over the past five years, compared to 5.5 percent in the U.S.
Over the past three years, the $3.2 billion WisdomTree Emerging Markets Equity Income ETF (3.9 percent yield, 0.63 expense ratio) was 18 percent less volatile than a benchmark index of emerging market stocks. In 2008 the portfolio of about 300 stocks declined 35 percent, vs. the 43 percent plunge for the benchmark index. And over the past three years, its 32 percent annualized gain bests the 26 percent average annualized gain for emerging market ETFs tracked by Morningstar.
Focus on Cash Dividends Paid, Not Just Yield. Oey prefers portfolios that weight holdings based on the size of the actual annual cash dividend paid, rather than just the highest current yield. WisdomTree follows the dividend-weighted approach with its 10 international dividend ETFs. “That gives you a slightly higher quality portfolio with a value tilt,” says Oey.