An Intelligent Idea for International Diversification | ETF Trends

While the S&P 500 set an impressive pace in the first quarter, gaining 10.4%, some ex-U.S. developed markets benchmarks showed signs of life. For example, the widely followed MSCI EAFE Index gained 6% in the first three months of 2024. It remains to be seen. However, that could be the start of something more substantial for an asset class that’s long trailed domestic stocks. Should that prove to be the case, exchange traded funds such as the WisdomTree International Quality Dividend Growth Fund (IQDG) could be on the receiving end of renewed attention from advisors and investors.

The $977.4 million IQDG follows the WisdomTree International Quality Dividend Growth Index. It provides exposure to a broad basket of developed market dividend payers, excluding U.S. and Canadian companies. IQDG notched a solid showing in the first quarter. Additionally, it could be poised for more upside as 2024 moves forward. And, perhaps more importantly, if the U.S. and other developed markets equities decouple from each other.

Correlation Conundrum Could Finally Break

For years now, market participants eschewed ex-U.S. developed markets fare. One of the primary reasons is because the asset class was highly correlated to domestic stocks while trailing in terms of total returns.

“From a diversification perspective, most international-stock benchmarks, especially those in developed markets, have been closely tied to the U.S. market over the past three years, as shown below. Developed-markets equities, especially European stocks, have had the tightest correlation with U.S. equities,” noted Morningstar’s Christine Benz.

In other words, those correlations have erased some of the diversification benefits associated with ETFs such as IQDG, but that case could be renewed because as history proves, there have been some multi-year stretches when the S&P 500 and comparable international gauges did not move in lockstep with each other. That scenario could be reborn if the Federal Reserve lowers interest rates and the dollar responds by turning lower.

“Correlations between the U.S. and international markets have been lower in some previous periods. Such as from 2004 through 2008, when the U.S. dollar was generally on the decline,” added Benz. “If the greenback goes into another longer-term slump or if the U.S. sinks into recession but other major non-U.S. markets manage to avoid one, it is conceivable that correlations between U.S. and international markets could again drift lower.”

IQDG could offer investors another advantage. Over the past 10 years, international developed markets indexes, broadly speaking, have been less volatile than U.S. equivalents. That favorable scenario could be heightened with IQDG owing to the ETF’s dividend status and favorable quality traits.

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