NEW YORK (Fabian Capital Management) -- Equity income investors are running into a key problem when constructing a diversified portfolio of dividend-paying stocks. Prices have risen to a point where the major domestic dividend indexes are now yielding a meager 3%.
The iShares Select Dividend ETF (DVY) and Vanguard High Yield Dividend ETF (VYM) are both constructed of high-quality companies that are characterized by their above-average dividend yields. However, both of these widely-owned exchange-traded funds have now seen their annual yields fall close to 3% and are in danger of slipping even farther.
While the last several years of growth have been exceptional for these ETFs and their underlying stocks, the pace of dividend growth has not been able to keep up with stock price gains. With many retirees and other conservative investors relying on their portfolio to generate a healthy income stream, a focus solely on domestic stocks leaves a lot to be desired.
One option is to diversify your portfolio with high-yield asset classes such as real estate investment trusts, preferred stocks, master limited partnerships and junk bonds. While that makes perfect sense in the context of a multi-asset solution, many of those areas are going to be subject to unique risks such as interest rate direction and credit concerns.
Fortunately, there are a number of overseas dividend options that may provide both better yield and a more attractive valuation proposition than domestic equities.
One ETF that has been a core holding in my clients' income portfolios for some time now is the iShares International Select Dividend ETF (IDV). This ETF is made up of 100 stocks of foreign developed companies primarily centered around Europe with a modest allocation to Australia as well. The current distribution yield on IDV is 4.28% and dividends are paid on a quarterly basis.
Another developed international ETF to consider for equity income is the First Trust STOXX European Select Dividend Index Fund (FDD). This ETF selects just 30 companies from the STOXX Europe 600 Index according to their dividend history and other fundamental metrics. Companies are then dividend weighted within the ETF, which produces a current yield of 3.91%. In addition, the listed Price/Earnings ratio of FDD is 12.27 as of 4/30/14, while DVY has a relatively expensive P/E of 19.32.
Moving farther down the relative valuation spectrum is the WisdomTree Emerging Markets Equity Income Fund (DEM). DEM has nearly $3.9 billion invested in 315 dividend-paying stocks of emerging market countries such as Russia, China, and Taiwan. This ETF is also dividend weighted and holdings must meet liquidity and market capitalization requirements.
Emerging markets have vastly underperformed domestic and developed country peers over the last several years, which may make them attractive for a reflation comeback. The financial and energy sectors make up the bulk of the underlying companies in DEM and the current yield is listed at 4.20%.
One thing to note with international equities is the quarterly dividends often experience peaks and valleys throughout the year. This lumpy income stream is due to companies distributing special dividends and fiscal year-end distributions that may not coincide with the relatively steady pace of domestic stocks.
Keep in mind, this can also lead to misguided metrics when comparing the varying yield statistics which is why you should carefully research the dividend histories of these ETFs.
Investing in international markets can be an excellent way to diversify your equity income portfolio and offers the potential for enhanced returns as well. While I don't recommend abandoning U.S. dividend-paying ETFs, you may want to consider complementing those holdings with select international positions.
In addition, with the recent return of global equity volatility, newcomers to these themes would be well served to implement a stop loss or sell discipline to limit downside risk.
At the time of publication the author had a position in IDV.
This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.
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