Looking across developed markets today, a common thread is that central bank policies have pushed interest rates to very low levels to support their economies. Looking at the major central banks—the U.S., the European Central Bank (ECB) and the Bank of Japan (BOJ)—it appears that Europe and Japan are still expanding their accommodative policies, while the U.S. is reducing1 and is anticipated to be the first among these banks to raise interest rates2.
This change has important implications for currencies that play a role in international equity returns. We believe it is important to maintain a globally diversified international equity portfolio, but we question the rationale of being fully exposed to foreign currencies.
Importance of Currency Considerations: The euro, Yen and British pound comprise 70%–75% of the MSCI EAFE Index 3, a benchmark many use for their international allocations. Our position: if investors have no view on which direction currencies are going to move, they should consider a 50/50 blend of currency-hedged equities.
• An investor who believes that the dollar is going to fall can shift weight to add more currency exposure; this would imply foreign currency appreciation, which can add to international equity returns.
• An investor who believes that foreign currencies are going to fall—or that the dollar is going to rise—can shift that allocation to more currency-hedged strategies, as unhedged exposure in this case can detract from international equity returns.
In this piece, we discuss a unique blend from WisdomTree for the developed international space. Our core developed international currency-hedged strategy focuses on Dividend Growers4. We think that marrying this approach with a focus on High Dividend Yielders5 provides a nice complement in the stock selection strategies and the resulting currency exposures.
High Dividend Yielders: These stocks are characterized by their relatively higher yields at each annual rebalance, and they fit in our “equity income” category. Simply put, these are the firms that presently have higher dividend payouts relative to their share prices. In this piece, these stocks are represented by the WisdomTree DEFA Equity Income Index
• Dividend Growers: We tend to think about the potential for future dividend growth from both the earnings growth and quality perspectives, with our criteria for inclusion split evenly between these two factors. These firms may not have the highest dividend yields presently, but we believe that they have the potential to increase their dividends in the future. In this piece, these firms are represented by the WisdomTree International Hedged Dividend Growth Index.
Viewed in combination, High Dividend Yielders are interesting as interest rates in developed markets remain low, and Dividend Growers provide diversification potential for the future, when both interest rates and inflation in developed markets may rise. We believe that the marriage of these two themes may connect where we are today from a macroeconomic perspective to where we may be heading in the future.
Sector Exposures: 50–50 Blend of High Dividend Yielders and Dividend Growers
One nice feature of this methodology is sector diversification. When we see a portfolio where the largest sector exposures are below 14%, we believe that it indicates a very balanced picture.
Marrying Dividend Growth and Dividend Yield for Balanced Sector Exposures
Some of the more notable details underlying the characteristics of this blend:
• Financials: High Dividend Yielders had nearly 25% exposure to Financials, but Dividend Growers had less than 2.5% exposure. It’s also worth mentioning that the resulting 13.6% weight to Financials in the blend represented an 11.8% under-weight compared to the MSCI EAFE Index, the most widely followed performance measure of broad, developed international equities.6