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Home>Research & Insights>Investment Insights>High-Quality International Stocks for a Slim Fee

High-Quality International Stocks for a Slim Fee

Vanguard International Dividend Appreciation focuses on profitable firms that have consistently increased their dividend payments.

Daniel Sotiroff, 08/09/2017

Vanguard International Dividend Appreciation VIGI uses a strict but sensible strategy to invest in profitable firms from developed and emerging markets. The strategy screens for stocks with consistent long-term dividend growth and caps individual weights to reduce its exposure stock-specific risks. This is a solid and attractively priced strategy, but the fund’s short track record limits it to a Morningstar Analyst Rating of Bronze.

The fund invests in large- and mid-cap stocks from developed and emerging markets, and screens for those that have increased their dividend payments for seven consecutive years. The strategy applies additional filters that eliminate stocks which may not be able to sustain their dividend growth.

Holdings are weighted by market capitalization, which helps mitigate turnover and transaction costs. Individual stocks are limited to 4% of the portfolio at the annual rebalance, which improves diversification. The top 10 holdings currently account for about one third of the portfolio.

Many foreign stocks tie their dividend payments to earnings. Therefore, companies that have a history of increasing their dividend payments are also likely to be those that have been consistently growing profitably. This fund’s return on invested capital comes in at 17.3%, compared with 12.5% for the MSCI ACWI ex-USA Growth Index. It also lands in the top quintile of the foreign large-growth Morningstar Category.

Tying dividend payments to earnings also introduces certain risks. This policy can cause dividend payments to be more volatile than simply paying a consistent dividend. Additionally, a narrow focus on firms that consistently increase their dividend payments can emphasize those that are paying out a large portion of their earnings, which leaves a smaller fraction available for management to reinvest in their business. However, that tends to be a bigger risk with funds that focus on dividend yield.

This fund was launched in February 2016 and has not had sufficient time to build a meaningful record. Its absolute and risk-adjusted returns from March 2016 through May 2017 have landed in the middle of the category.

Fundamental View
Many of the fund’s dividend-oriented peers emphasize dividend yield rather than growth, but a narrow focus on yield brings about certain risks. High yields can be an indicator of firms that may be in financial distress, or have poor forward-looking prospects. These stocks trade at lower prices relative to dividends paid, and can be risky. Other high-yielding stocks may be paying out a large fraction of their earnings. These companies may be at risk of cutting their dividends because increasing payments in the future is unsustainable. Funds that hold these stocks tend to be more value-oriented, and more volatile than a broad market-cap-weighted index.

In contrast, this strategy focuses on dividend growth, which emphasizes companies that are more profitable and less likely to be in financial distress than their high-yielding counterparts. Consequently, this fund’s yield is lower than these yield-centric funds. Instead, the stocks in this portfolio typically represent highly profitable companies with strong underlying businesses. Strategies that invest in highly profitable companies have sound investment merit. In his 2012 paper, “The Other Side of Value,” Robert Novy-Marx demonstrated that profitable firms have historically outperformed unprofitable firms, and are less prone to distress.

Daniel Sotiroff is an analyst, passive strategies research, for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc.

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