FIDI - IDV: Still The Best Option For Income Protection

2023-06-22 05:23:21 ET

Summary

• The IDV ETF offers income-oriented investors exposure to developed markets, while avoiding emerging market volatility.
• IDV serves as a hedge against poor US economic performance, as it tends to move inversely to the US dollar index, providing a stable income stream and consistent distributions.
• Even though IDV hasn't delivered great results since its inception, it's still the best option for investors looking to diversify their income source among strong currencies.
• Investors looking to construct a solid income-generation portfolio may consider complementing IDV with options like FREL, for exposure to the US real estate market, or SCHD for high-paying US stocks.

Investment Thesis

In my view, The iShares International Select Dividend ETF ( IDV ) is a great investment option for income-oriented investors seeking exposure to developed markets while avoiding the volatility associated with emerging markets. In summary, you should have a holder approach and do not expect great share appreciation, but a hedged income in the event that US stocks perform badly.

IDV's unique trait lies in its exclusive focus on developed markets , something that no other income-oriented ETF has. By excluding emerging markets, the fund offers income from generally stable currencies and reduces exposure to the risks often associated with developing economies.

The fund’s main screening factor for picking its holdings is dividend yield and, while this approach has both pros and cons, it managed to provide a high yield with quarterly distributions since its inception. This aspect makes IDV appealing to investors looking for regular cash flow.

IDV tends to perform inversely to the US dollar index ( DXY ). For long-term investors, this feature can serve as an income hedge in the event of poor performance in the US economy during a given period. This diversification benefit adds stability to the portfolio. The fund is also not made for investors that aim for share price appreciation, as most of the companies within the fund portfolio are not from high-growth sectors and most of them prefer to distribute their earnings rather than invest in the business.

Currently, IDV trades at a relatively low price-to-earnings (P/E) ratio of 5.47 and a price-to-book (P/B) ratio of 0.89, both below the market average. These multiples indicate that the fund might be cheap at the moment, aligning with its high-yielding nature. However, I’d like to state again that significant share appreciation should not be expected from this investment.

A brief description of IDV

IDV is an exchange-traded fund that seeks to track the investment results of an index, the Dow Jones EPAC Select Dividend Index, composed of international equities that have a consistent track record of dividend payments. As I write this article, the fund has $4.74B assets under management ((AUM)) and is controlled by BlackRock, one of the largest asset management companies globally.

IDV provides investors with exposure to dividend-paying stocks from non-U.S. markets and aims to capture income potential and diversification benefits from international markets while focusing on companies with a history of paying dividends. The ETF's holdings typically include stocks from various sectors and countries outside the United States, with an emphasis on dividend yield and dividend sustainability.

IDV has an annual expense ratio of 0.49% and it does not invest in REITS. It will invest at least 80% of its assets in holdings contained in the market benchmark it follows. As I write this article, the fund has most of its holdings in the financial sector, with 26.97%, and the least amount in the technology sector, with 0.36%. Some of the companies with the most weight in the fund’s portfolio are: Rio Tinto Group (RIO), BHP Group Limited (BHP), and British American Tobacco (BTI).

Diversification across strong economies

As I said, IDV is different from other income-oriented ETFs in the sense that it focuses on developed countries. The top 5 geographies in which the fund is currently invested are the United Kingdom (14.76%), Canada (10.29%), Australia (8.64%), South Korea (8.53%), and Spain (7.52%). Investing in mature economies rather than emerging ones provides a safer income generation for investors that prioritize this type of investment. Most developed countries have well-established currencies that are able to offer protection against the ramping inflation that affect developing economies.

Don’t take me wrong, I believe investing in developing markets is of the utmost importance and every investor should consider it. But, when it comes to income generation, I’m not a big fan of relying on economies that have a great chance of deteriorating their national currencies. That’s a risk inherent to “small-cap” countries with which I'm quite acquainted. As a native Brazilian, I experience on a daily basis what is to have your purchasing power affected in relatively short timeframes, and in a bad way. So, my investment philosophy approaches emerging markets in a passive manner, aiming for capital appreciation in the long run and not relying on their distributions. If you have the same or a similar approach as mine, you should consider studying the Vanguard FTSE Emerging Markets Index Fund ETF ( VWO ) to see if it’s a possible fit in your portfolio, in case you don’t own it yet.

Now, even though the US has delivered great results in the past, trusting it will deliver again in the following years is not a conservative bet. And even so, investors that aim for income generation usually prefer less volatile scenarios, making sure that the distributions keep coming in regardless of market conditions – and preferably in the form of currencies not degraded by inflation. Although the US has held the title of the safest economy for quite a while, it still did not escape experiencing strong bear markets and intense volatility throughout the years. So, positioning IDV wisely in your portfolio can prove to be a tremendous hedge against periods when the US economy is not performing well.

IDV moves almost 100% inversely to the US Dollar Index (see graph below), showing that the market tends to migrate to other strong currencies when the US economy does not show good prospects. The opposite is also true, when the US market has its bonanza period, investors tend to bring their assets back to it. Income-seeking investors that prioritize income safety can solve this back-and-forth dance by being exposed to both US and developed markets securities.

In my opinion, a great additional option to complement one's income-generation portfolio is the Fidelity MSCI Real Estate Index ETF ( FREL ), which focuses on the American real estate market, or the Schwab U.S. Dividend Equity ETF ( SCHD ), which aims for high-paying US stocks in general.

The developed markets delivered mild returns in the past decade

It’s market common sense that companies that focus on distributions rather than reinvest in their businesses tend to appreciate less in the long run. We also know that this theory has flaws and exceptions and that we can’t generalize the entire high-yield stocks group as not having delivered results over the years. So, the metric that ends once and for all this discussion is the payout ratio, which can be proved by historical results in this article .

It’s true that IDV's share price hasn’t been good to shareholders since its inception. Actually, if it wasn’t for the dividends, the overall return would be -47.44% (first image below), but that’s because the fund inception was at the peak of the housing bubble. If we analyzed IDV’s share price returns starting in 2010 – after the biggest dip of the crash – they would be slightly better at -16.78% (second image). Now, if we take this same period and account for the dividends distributed, the total shareholder’s returns would be +74.87% (third image).

The reason for this mild performance, in my opinion, is not because high-paying stocks deliver poorer results than their counterparts, but because the developed markets themselves haven’t performed that awesome in the past decade. The image below compares the returns from both IDV and Vanguard FTSE Developed Markets Index Fund ETF ( VEA ), proving that “regular” companies that don’t prioritize distributions also delivered similar results.

To be honest, the past decade was USA’s time to shine, which makes the returns of both S&P 500 and US high-paying stocks trample those from the developed markets. To make it clearer, please check the image below comparing the returns of IDV, VEA, SCHD, and the S&P500.

Even considering all the comparisons above, I still believe IDV delivers what it promises, and that investors shouldn’t use past results as indicative of future returns. Even with the mild results delivered, IDV still provides income protection from international companies, especially if combined with income-generating assets from the US. And who can state with 100% certainty that the next bonanza period will not come from the developed markets? So, if you prioritize safe and recurring dividends, geographical diversification is your best bet, and you can definitely acquire that by investing in IDV.

Potential risks and how to handle them

Since no one can predict how the financial markets will behave in the future, there is also a chance that the developed economies will fail to deliver great results again. Europe overall is still struggling to control its inflation and, on top of that, a war that doesn’t seem to end is affecting the entire production chain in the region. At first glance, the prospects don’t look that good for IDV’s near future but, in my opinion, long-term investors shouldn’t change their portfolio allocations based on things they can’t control.

Income-seeking investors that wish to implement some sort of hedge to their distributions should know that portfolio allocation is ultimately the most important factor. If you fall into that category, you should have a pre-established weight for each of your holdings, preferably through geographical diversification, as I mentioned earlier. We can’t predict which markets will perform best the moment we purchase our shares, so having income flowing in from different parts of the globe is how we should approach the risks inherent to this type of investing.

And for those who like to assess their investment through price multiples, IDV is currently trading at relatively low P/E and Price/Book ratios of 5.47 and 0.89, respectively, when compared to peer ETFs like the iShares International Select Dividend ( DWX ), Vanguard International High Dividend Yield Index Fund ( VYMI ), and Fidelity® International High Dividend ( FIDI ). Although those figures are lower than the market average, you should take them with a grain of salt, after all, IDV focuses on stocks with high dividend yield. We all know that dividend yield, by definition, is a multiple heavily affected by share price, which means that keeping price multiples at low levels should be interpreted as the fund’s way of “only doing its job”.

Sometimes stock prices are low for a reason, maybe because the business isn’t as profitable as before, but IDV would invest in them anyway because the dividend yield is high. In my view, this aspect has a partial fault in the fund’s unsatisfactory performance over the past decade. The chart below proves this point by showing that the quality factor isn’t a priority for the fund, so companies with weak and medium balance sheets can squeeze in among the holdings.

Conclusion

IDV offers income-oriented investors exposure to developed markets while avoiding the volatility of emerging markets. Its exclusive focus on developed countries provides a safer income generation with stable currencies and reduces risks associated with developing economies. The fund's emphasis on dividend yield has delivered a high yield with quarterly distributions, making it appealing for investors seeking regular cash flow.

IDV serves as a hedge against poor US economic performance, as it tends to move inversely to the US dollar index. By diversifying across the US and developed markets securities, investors can ensure a stable income stream and consistent distributions, regardless of market conditions. IDV is not the best choice for those seeking significant share appreciation and, although its current low P/E and P/B ratios are lower than its peers, it’s actually in line with the fund’s high-yielding nature.

Investors looking to construct a solid income-generation portfolio may consider complementing IDV with options like FREL, for exposure to the US real estate market, or SCHD for high-paying US stocks. It's important to note that past performance is not indicative of future results, so the next decade can deliver the exact opposite results as those from the past one. However, by prioritizing income safety, diversifying across developed markets, and maintaining a long-term investment approach, investors can mitigate risks and incorporate the full benefits of geographical diversification without worrying about factors they have no control over.

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