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This Dividend Strategy Emphasizes Shareholder-Friendly Companies

Consistent dividend growth is key.

High-quality companies often have a defensive bent, making them a welcome addition to a diversified portfolio. They can be less volatile than the market and hold up better during drawdowns. Consistent dividend growth is a good proxy for quality because it demonstrates that the business is healthy, stable, and run by a shareholder-friendly management team.

Vanguard International Dividend Appreciation ETF VIGI looks for these stocks listed on foreign exchanges, pushing it toward high-quality firms with consistent dividend growth that should offer attractive long-term performance. Morningstar's enhanced ratings framework has recognized this fund's low fee as a meaningful advantage. It earns a Morningstar Analyst Rating upgrade to Silver from Bronze.

The fund tracks the Nasdaq International Dividend Achievers Select Index. It targets large- and mid-cap stocks from developed and emerging markets that have increased their dividend payments for at least seven consecutive years. It applies additional filters to eliminate names that may not be able to sustain their dividend growth. The index weights its holdings by market cap to help mitigate turnover and trading costs. It also limits individual stocks to 4% of the portfolio at the annual rebalance to improve diversification.

Targeting stocks with seven years of dividend growth is a strict hurdle that should give the fund an edge. It indirectly targets profitable companies that not only have the capacity to make dividend payments but also a willingness to do so. But this screen does have some downsides. It doesn't consider other metrics, such as debt levels and analyst earnings growth estimates, which may be indicative of a firm's capacity to continue making payments. Additionally, if a company were to miss a single dividend payment, it must wait seven years before it is welcomed back.

Overseas companies that have a history of increasing their dividend payments also tend to have consistent profitable growth. These types of businesses should be less volatile than the broader market and are likely to hold up better during market downturns.

The high-quality names in this portfolio held up well when the market declined in 2018, beating the MSCI All Country World Index ex USA Growth by 6.5 percentage points annually between March 2018 and May 2019. But it lagged the index by 86 basis points annually from its launch in February 2016 through May 2020. The fund's 0.20% expense ratio ranks among the lowest in the category and should provide a long-term advantage.

Process This fund targets companies with a consistent history of raising their dividend payments, which leads to a portfolio of shareholder-friendly firms that should provide solid performance. It earns an Above Average Process Pillar rating.

The portfolio managers use full replication to track the Nasdaq International Dividend Achievers Select Index. This benchmark starts with all stocks in the Nasdaq Global Ex U.S. Index, which includes companies listed in both developed and emerging markets. The process excludes REITs and firms that are currently working through bankruptcy proceedings. It applies additional liquidity screens to ensure potential holdings are investable. The methodology further narrows down its selection to companies that have a seven-year history of increasing regular dividend payments. Nasdaq applies some additional proprietary filters intended to improve the fund's chances of holding companies that will continue to grow their dividends. The index weights stocks that meet these criteria by market cap, subject to a 4% maximum weighting at the time of the rebalance. The index reconstitutes annually in March.

The stocks in this portfolio tend to have shareholder-friendly management. They not only have the capacity to increase dividend payments but also the willingness to do so. These firms typically trade at higher multiples than the market. But they are also more profitable, and the portfolio's return on invested capital has consistently been higher than the MSCI ACWI ex USA Growth. An acute emphasis on dividend growth also means this fund's yield tends to run lower than the broader foreign stock market, and it should not be considered for those seeking a higher level of income than the market.

Focusing on dividend growth causes the portfolio to favor stocks from stable sectors like healthcare and consumer staples. And the strategy's market-cap-weighted approach emphasizes the largest names in the portfolio. Top holdings include major multinational firms Roche, Nestle, and L'Oreal. These companies tend to be less volatile than the broader market and can hold up better during market downturns. Market-cap weighting also promotes low turnover, which typically lands in the high single digits.

Like many of its peers, the fund has some exposure to emerging markets. They represent about 25% of the portfolio and carry greater risk than their developed-markets counterparts. Additional sources of risk include greater political risk, underdeveloped infrastructure, and regulatory oversight.

Performance This strategy has potential, but it has not stood out from the MSCI ACWI ex USA Growth. The high-quality companies in this portfolio tend to lag when the market rallies and outperform during downturns. Consistent with that expectation, the fund lagged the benchmark by 4.2 percentage points during the 2017 bull market, then beat the index by 3.1 percentage points during the ensuing 2018 decline. But that pattern isn't guaranteed to hold. It lost 18.8 percentage points during the coronavirus-driven sell-off in the first quarter of 2020, which was comparable to the benchmark. Overall, it lagged the index by 86 basis points annually from its launch in February 2016 through May 2020.

The portfolio's emphasis on businesses with long-term dividend growth can tilt it toward stable businesses that tend to be less risky than the market. So far, the fund's standard deviation has been slightly lower than the MSCI ACWI ex USA Growth from launch through May 2020.

The fund's tracking error looks high because Vanguard uses a fair value pricing strategy to update stale stock prices and protect investors from arbitrage activity. Its total return from February 2016 through May 2020 was in line with its target index after accounting for its expense ratio, indicating that the managers are fulfilling the fund's index-tracking mandate.

People The portfolio managers on this fund are part of Vanguard's equity index group. This wider team has a global footprint and uses the latest in portfolio management technology to track the fund's target index. The team earns an Above Average People Pillar rating.

Michael Perre and Justin Hales share responsibility for this fund. Perre is a principal at Vanguard, while Hales is a portfolio manager. Both have more than a decade of experience at Vanguard and help captain some of the firm's largest index-tracking funds listed in North America.

This duo not only oversees the portfolio but also executes trades on a day-to-day basis. Vanguard typically rotates portfolio managers around from one fund to another every few years to improve their breadth and depth of expertise. They also have access to Vanguard's global trading desks, enabling them to make the most cost-efficient transactions in various global markets.

Vanguard's portfolio managers are compensated with a bonus that factors in the gross, pretax performance of the fund relative to its objectives. This includes the manager's record of tracking a benchmark index over the prior 12 months. This aligns the interests of the managers and investors.

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About the Author

Daniel Sotiroff

Senior Analyst
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Daniel Sotiroff is a senior manager research analyst for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. He covers passive strategies.

Before joining Morningstar in 2017, Sotiroff was as a design engineer at Caterpillar, where he worked on front-end loaders for heavy construction and mining applications.

Sotiroff holds a bachelor's degree in mechanical engineering and a master's degree in applied mechanics, both from Northern Illinois University.

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