Check This Out Before Jumping Aboard International Dividend ETFs

Passively managed, rules-based international equity exchange-traded funds can sometimes result in large country bets. At times, these country bets can be an unintended source of risk, especially if the fund is overweight in a country that has a volatile equity market and/or currency. Below is our ETF Report on

With a current yield of almost 6%, iShares International Select Dividend is one of the highest-yielding international equity funds.

This passively managed, rules-based ETF holds 100 high-dividend-yielding companies from developed Europe, Asia-Pacific, and Canada that have passed a series of dividend sustainability screens. Like most dividend-oriented funds, it has a value tilt.

Because of its dividend focus, this fund's country weightings can differ significantly from those of its foreign large-value Morningstar Category peers. Australian companies tend to pay out high dividends, whereas Japanese companies tend to pay out low dividends, relative to the global average. As a result, this fund has generally had a large allocation in Australia (20% to 30%, versus around 6% for the MSCI World ex USA Index) and a very low weighting in Japan (currently less than 1%, versus 20% for the benchmark). At times, these differences can drive this ETF's out- or underperformance relative to category peers. Those considering this fund should be comfortable with these country tilts. In addition, this fund's large weighting in Australian stocks is a source of risk, as the Australian dollar is more volatile given the Australian economy's commodity orientation.

Like most of its international-equity fund peers, this fund does not hedge its currency exposure, so its returns reflect both changes in local stock prices and translation effects when the value of this fund's holdings is converted into U.S. dollars. In the 10-year period through December 2012, a rising euro, followed by a rising yen (against the U.S. dollar), helped boost the performance of international-equity funds. More recently, however, the rising dollar has hurt the fund's performance. But generally speaking, developed-markets currencies move in a cyclical fashion, so over the long term, currency fluctuations tend to have a negligible impact on total returns.

Fundamental View Most dividend funds can be classified as either income-focused or total-return-oriented. This fund is one of the former, as it aims to provide a high level of current income instead of a more conservative approach of capital appreciation and yield. However, simply selecting the highest-yielding stocks can be risky, as some high-yielding stocks may be companies with poor fundamentals whose stock prices are trading at low valuations. To screen out potentially distressed names, this fund's index requires companies to meet certain dividend sustainability requirements, such as dividend-per-share growth and a minimum dividend coverage ratio. Prior to the 2008 financial crisis, the fund's valuation multiples were lower than those of its category peers, and subsequently it saw a maximum drawdown of 62%, much greater than the category average's decline of 54%. This suggests the fund may have been holding riskier names and that its dividend sustainability screens do not always work effectively. However, since then, the fund's valuation multiples have been more in line with those of its category peers.

During the past few years, this fund's annual dividends per share have been on a steady upward trend, starting at $1.06 in 2009 and rising to $1.93 in 2014. However, the recent 10% decline in the Australian dollar to the U.S. dollar in 2015 may have a negative impact on the total dividends paid in 2015, as dividends are distributed in local currency to the ETF and converted into U.S. dollars before being paid out to shareholders. Currency movements can be an issue if there is a sharp decline in the local currencies of this fund's larger country allocations, such as Australia, the United Kingdom, and the eurozone. Investors looking for a vehicle to provide consistent dividends may want to consider other options.

Country allocations can also affect this fund's relative performance. During the past few years, this fund has had about a 1%-2% allocation in Japan, significantly lower than the category average of 15%. This underweighting in Japan was a headwind for this fund when Japanese stocks (in U.S. dollars) rallied in 2013 and 2015. This ETF's current large allocation in Australia is now detracting from returns, as the falling Australian dollar has affected the returns of Australian stocks (in U.S.-dollar terms).

This ETF's current largest holdings are high-quality firms. These include Australian banks (

Portfolio Construction This fund employs full replication to track the Dow Jones Europe, Pacific, Asia and Canada Select Dividend Index, which contains 100 high-yielding stocks domiciled in developed markets. Constituents must pass a number of screens to become eligible for inclusion. Dividends must have been maintained or raised each of the previous three years, the prior-year dividend per-share ratio must be equal to or greater than the three-year average, and the trailing 12-month earnings per share cannot be negative. Once the investable universe is determined, each country's indicated dividend yield and each stock's indicated annual dividend within its country are calculated. Companies are then weighted by multiplying these two values. Existing constituents that are within the top 200 are kept in the index, and new constituents are added until the index has 100 holdings. This is done to reduce turnover. The index and the fund are rebalanced in March. Historically, relative to other funds in the category, this ETF has generally had lower weightings in healthcare and materials, and higher weightings in utilities and telecoms. As for country exposure, relative to its peers, this fund has generally had a higher exposure to Australian companies and a lower exposure to Japanese companies. However, this fund's country and sector weightings can shift during the annual rebalance.

Fees The fund's 0.50% expense ratio is in line with those of other international dividend-focused ETFs. Index funds should provide the returns of its benchmark, less fees. During the past three years, this fund trailed its index by 19 basis points, annualized, which is less than the fund's annual fee. This indicates the fund is doing a good job tracking its index. A portion of the fund's distribution is withheld for foreign tax purposes from companies in some countries, and the dividend yield figure is net of this tax. Investors can file for a foreign tax credit to offset these taxes, but not if the fund is held in a tax-advantaged account. During the past three years, about 90% of the dividends from this ETF were treated as qualified dividend income.

Alternatives International dividend ETFs (and indexes) are relatively new and have track records of less than 10 years. As such, they are not really tried and tested. Depending on their index construction rules, these funds can have significant country tilts versus the market-cap-weighted benchmark. Generally speaking, these funds tend to have heavy weightings in Australia and low weightings in Japan, and these tilts have negatively affected performance relative to the benchmark during the past few years.

There are currently three international-equity dividend funds that are yielding more than 5%. SPDR S&P International Dividend DWX is one, and its annual fee is 0.45%. The two other funds, Global X SuperDividend SDIV and First Trust Dow Jones Global Select Dividend FGD, invest globally (which means they also invest in U.S. companies). Each fund has significantly underperformed the MSCI World Index. SDIV and FGD carry annual expense ratios of 0.58% and 0.60%, respectively.

Those who are not so yield-oriented can consider PowerShares International Dividend Achievers PID, which currently yields around 4%. This fund requires constituents to exhibit five years of consecutive dividend growth, which acts as a quality screen. It is one of the more total-return-focused international dividend ETFs, as opposed to an aggressively income-oriented strategy. PID costs 0.55% a year.

The U.S. equity version of IDV is

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