U.S. investors may be hindered in meeting their investment goals due to their underexposure to international markets.
With the volatility in equities this year and weakness in technology amid rising interest rates and supply chain issues, it could be an opportune time for income investors to reconsider their international exposures, Stacey Morris, CFA, head of energy research at VettaFi, wrote in an insight.
Developed market equities can provide both diversification benefits and yield enhancement to an income portfolio. Beyond adding exposure to stocks that would otherwise not be included in a U.S.-focused income portfolio, international equities may also be attractive due to lower correlations with other common income investments, according to Morris.
“Five-year correlations between international equities and REITs and utilities are around 0.6. International companies also tend to provide more generous income,” Morris wrote. “The five-year average yield for the MSCI EAFE Index (MXEA) is 140 basis points higher than that of the S&P 500 (SPX).”
Morris said that international equities come with additional risks, such as geopolitical risk and foreign currency risk, that should not be dismissed but are likely manageable in a well-diversified portfolio.
A simple yield-focused strategy could be an interesting way to gain international exposure and boost portfolio income.
The S-Network International Sector Dividend Dogs Index (IDOGX), which is the underlying index for the ALPS International Sector Dividend Dogs ETF (IDOG), selects the five companies with the highest dividend yields in each of the 10 GICS sectors — excluding real estate — from a starting universe of mostly large-cap stocks that are domiciled in developed markets outside of the Americas. The 50 stocks are weighted equally, providing diversified sector exposure, according to Morris.
Each security’s equal weight in the fund has contributed to IDOGX’s strong performance in a challenging year, Morris said. Relative to benchmarks, IDOGX is overweight to energy, which has done extremely well this year amid rising oil and natural gas prices. Year-to-date through May 31, IDOGX is up 2.8% on a total-return basis compared to declines for the MXEA and SPX of -11.0% and -12.8%, respectively. IDOGX was yielding 5.4% at the end of May — 200 basis points above the MXEA, according to Morris.
For investors who would be interested in a domestic strategy with enhanced yield and an equal-weighting scheme, the S-Network Sector Dividend Dogs Index (SDOGX) deploys the same approach as IDOGX but has the S&P 500 as its starting universe. At the end of May, SDOGX, which is the underlying index for the ALPS Sector Dividend Dogs ETF (SDOG), was yielding 4.0% and was up 5.6% on a total-return basis year-to-date, Morris said.
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vettafi.com is owned by VettaFi, which also owns the index provider for IDOG and SDOG. VettaFi is not the sponsor of IDOG and SDOG, but VettaFi’s affiliate receives an index licensing fee from the ETF sponsor.