Investors have been on a neverending search for dividends in recent years, but the quest has been largely confined to the U.S. market. And this home-market bias, while a natural instinct for many investors, might be causing people to miss the boat on the even more attractive opportunities overseas.
International dividend ETFs, as a group, offer both higher yields and lower valuations than their domestic counterparts. If you own dividend ETFs and you aren’t diversified overseas, it’s time to ask yourself why.
Consider this: Etfdb.com shows that $92.4 billion is allocated to dividend ETFs. Of this, a full 59% is dedicated to just four funds, all of them domestic:
At the same time, only a little more than 16% of the total is dedicated to international or global dividend ETFs, even though these funds make up 38 of the 80 funds (or 47.5%) in etfdb’s database.
The (most likely) reason for this disconnect is that the average dividend investor is more comfortable owning the kinds of household names that show up in DVY’s portfolio — Lockheed Martin (LMT), Philip Morris (PM), Chevron (CVX) — rather than the more obscure stocks that typically appear in international ETFs.
So far, this bias has worked out just fine given that the U.S. market has outperformed both its developed- and emerging-market peers by a huge margin in the past five years. But at this point, it’s time to look forward.
While the outlook for economic growth outside of the U.S. is highly questionable, the “decoupling” trade — where the U.S. continues to grow at 2%-3% while the overseas markets flounder — is fully priced in. If the U.S. begins to feel the pinch of slower global growth, mean reversion could quickly come into play.
But let’s say this doesn’t happen, and that the headlines from the international markets remain negative. Even in this scenario, the starting point for international dividend ETFs is still very favorable.
For example, an investor in the iShares Select Dividend ETF (DVY), SPDR S&P Dividend ETF (SDY), or PowerShares Exchange Traded Fund Trust Dividend Achievers Portfolio (PFM) should consider the difference between the yields and valuations of the international options. In addition, the large gap in recent performance provides the opportunity to buy into an asset class that hasn’t been as picked over as domestic dividend stocks:
Even in the small-cap space, where the yields are roughly the same, international funds have an advantage in terms of valuation:
Naturally, international dividend ETFs don’t offer investors a free lunch. They tend to be more volatile, in many cases they’re exposed to currency risk, and the expense ratios tend to be higher. And, as is the case with domestic ETFs, it’s necessary to dig into the individual portfolios to find if what they own is suitable for your needs.
Nevertheless, it’s clear investors are being fairly compensated in terms of both superior yields and the higher long-term total return potential stemming their attractive valuations.
It’s also important to keep in mind that the international markets are where the U.S. was in 2011, with dividend yields on stocks far above what can be earned in bonds. In Germany, for instance, the yield on the 10-year note has fallen to 0.82% — well below the 2.3% yield available on German equities — amid concerns about slower growth. In fact, 29 of the 30 stocks in the German DAX Index offer yields higher than the German 10-year.
With just a whiff of confidence returning to the market, the 3.2% yield on a stock such as Allianz (AZSEY) is going to become very attractive in comparison.
This disparity isn’t specific to Germany; it exists across all of the major markets, the U.K., France and Japan included. While this doesn’t translate into immediate outperformance — it has been the case for quite some time, after all — it represents another pillar of support for long-term performance, a key factor for anyone who plans to buy and hold dividend ETFs.
The Bottom Line
The international markets certainly aren’t out of the woods yet, and it’s possible they could suffer additional underperformance relative to the U.S. Still, the recent decline in stock prices provides a very compelling opportunity over a five- to 10-year time frame.
For yield-oriented investors, the time to move beyond U.S. borders has arrived.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.