Reap the Dividends of a Foreign ETF

This column was originally published on RealMoney on Sept. 16 at 12:04 p.m. EDT. It's being republished as a bonus for TheStreet.com readers.

At their high-water mark in financial history, dividends accounted for as much as 42% of total returns. At other times, like the 1990s, they have been out of favor.

They're back in vogue now, and if, as some people expect, U.S. equity returns are below average the next few years, they will stay in the spotlight.

The ETF industry has rolled out several products to provide higher yields. The first dividend-focused ETF was the iShares Dow Jones Select Dividend Index Fund (DVY). There is also the PowerShares High Yield Dividend Achievers Fund(PEY), which was listed last December. Both ETFs own high-yielding domestic stocks.

PowerShares has created an innovative twist on the concept with the High Yield International Dividend Achievers Fund(PID), which mimics the Mergent International Dividend Achievers Index (DAT). PID has been in the works for months and began trading Sept. 15.

PID owns 42 stocks, according to the PowerShares Web site (48 holdings, according to the press release), and yields 3% based on its issue price. Criteria for inclusion are foreign companies that have increased dividends per share for five years. All of the components are ADRs, though the fund holds several Bermuda-based companies that some may not consider to be truly foreign.

I am a big believer in dividends and foreign investing, so PID is right up my alley. I plan to use the fund for certain clients with a low tolerance for single-stock risk but who need equity exposure.

However, there are a couple of flaws that prospective investors should understand.

PID has a 41.66% weighting in the financial sector. It is no surprise that it has a lot of financials, but this is a heavy weighting when compared to any broad benchmark. Domestic financial stocks have struggled and may continue to do so because of a flatter yield curve and a potentially slowing economy. These problems may or may not spill over into financial stocks from other countries, but it's this type of heavy exposure in one sector in several funds that often causes investors to end up with lopsided portfolios.

One other thing about the financial composition of the fund is that PID owns all five of the big Canadian banks, totaling 13% of the fund. In fact, 20% of the fund is invested in Canada. I'm a big fan of the Canadian theme, and most of my clients are invested in one of the banks owned by the fund. As a commodity-based economy, Canada stands to benefit from what continues to be a positive environment for natural resources.

Although banks are obviously not commodities, a downturn in the market for natural resources would hurt the Canadian economy, and by extension, Canadian banks. A total of 31.48% of the fund is invested in what I would call commodity-based economies.

Another point of concern is that 18.05% of the fund is invested in emerging markets. I maintain about a 5% to 7% weighting in emerging markets for most clients. PID's emerging markets exposure might be too heavy for some investors, or more likely would mean there should be less emerging markets exposure elsewhere in their portfolio.

One last quirk in the portfolio is there is no telecom exposure. If no telecom stocks met the five-year threshold, so be it, but this tells me that future changes to the composition of the fund could create even less balance than now.

Those are the drawbacks. However, there are plenty of positives that I believe will make PID a great tool in a diversified portfolio. Foreign and high-dividend yields are important themes in today's market. If some of the gloomy and dire predictions about the U.S. market pan out in the coming years, foreign and high-yielding assets will become even more important to U.S.-based investors. PID offers a relatively safe and transparent way to capture this effect.

As the following chart from The PowerShares Web site shows, the Mergent International Dividend Achievers Index, the index PID is modeled on, has done well vs. the MSCI EAFE, a common international stock benchmark.

High Achievement The Mergent International Dividend Achievers Index has outperformed the MSCI EAFE over the past decade.

Source: PowerShares

I expect that it, and PID, would outperform in an environment of lackluster index returns.

There is also a chance to enhance PID's yield by selling call options. As is often the case with PowerShares products, options were listed right away. As is also the case with many ETF options, the premiums are quite low and selling any covered calls should be done selectively. Midday Thursday, PID call options expiring in March struck at 16 were bid at $0.25 while calls struck at 17 and 18 had no bid.

I don't find getting paid $0.25 for six months, only one point out of the money, very compelling. However, at some point a compelling trade with covered calls might present itself.

I plan to use PID for some clients, but I also plan to wait a few weeks. When a new product comes to market, I like to get a feel for how it trades and reacts to various kinds of market news. I like the fund, but I don't feel the urgency to own it yesterday.

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