VIGI - VIGI Has A Quality Portfolio But We Prefer Other Alternatives

Summary

• Vanguard International Dividend Appreciation ETF invests in large-cap dividend growth stocks across the world, excluding stocks in the U.S. market.
• Its fund price has an inverse correlation to the U.S. dollar index.
• VIGI’s long-term growth potential appears to be inferior to its U.S. peers and has more downside risk.

ETF Overview

Vanguard International Dividend Appreciation ETF ( VIGI ) includes a portfolio of large cap international stocks with 7 or more consecutive years of dividend growth. Its exposure to large-cap stocks is beneficial, as these stocks should be better prepared to handle any macroeconomic headwinds. While delivering positive return since its inception, VIGI has underperformed in the long-run to its peers that focuses on large-cap dividend growth stocks in the U.S. market. In addition, VIGI has a high downside risk as it has a strong inverse correlation to the U.S. dollar. Therefore, we do not think VIGI is a good choice for long-term investors.

Fund Analysis

VIGI delivered positive returns since its inception

VIGI has delivered positive returns since its inception in February 2016 with a total return of 67.46%. Without considering the dividends, the fund also gained 41.01%. While VIGI's performance was good, it was not the best. As can be seen from the chart below, its peers Vanguard Dividend Appreciation ETF ( VIG ) and iShares Core Dividend Growth ETF ( DGRO ), which includes only U.S. dividend growth stocks, delivered total returns of 131.7% and 139.4% respectively.

The underperformance of VIGI to VIG and DGRO was primarily due to VIGI's inferior earnings growth profile in its portfolio. As can be seen from the table below, VIGI's average earnings growth rate in the past 5 years was about 11.2%. This was more than 5 percentage points lower than VIG's 16.4%. This has a direct impact on Return on Equity as well. As can be seen from the table, VIGI's ROE of 17.3% was lower than VIG's 26.3%.

Source: Vanguard Website

Downside risk can still be very high for VIGI

Since VIGI only includes large-cap stocks that have increased their dividends for 7 consecutive years, one might expect that its fund price will be much more stable in a bear market. Companies that can increase their dividends for a lengthy period usually means that they can at least handle an economic downturn or business headwinds. In addition, the fund only has minimal exposure to emerging markets. As the table below shows, emerging markets only represent about 13.4% of VIGI's total portfolio. The rest are developed markets located in different regions of the world.

As discussed in the previous paragraph, we would expect VIGI to be quite stable especially during market turmoil. Unfortunately, this is not the case with VIGI. As the chart below shows, VIGI's fund price has declined by more than 30% during the 2020 crash due to the outbreak of global pandemic. Similarly, its fund price has fallen nearly 36% from the peak in mid-2021 to its trough in late 2022. This is much more severe than VIG and DGRO, which have fallen only by roughly 20% in the same period.

Investors should pay attention to the U.S. dollar and treasury yield

The difference between VIGI and its U.S. peers VIG and DGRO in a market downturn such as last year was primarily due to a strong U.S. dollar and the Federal Reserve's monetary policy. Last year was the year that the Federal Reserve aggressively hiked its rate. As the rate increases, money will flow from risk assets towards non-risk assets such as U.S. treasury. As rate increase accelerates, more money will flow out of non-U.S. markets as well. Since foreign equities in general are usually considered as having higher risks than U.S. equities, money will especially flow from these assets back to the United States. This will cause depreciation to these assets. The Federal Reserve's policy last year has also caused a strengthening dollar. As the dollar strengthens, VIGI, which is calculated in U.S. dollar, will also see value depreciation.

Below is a chart that shows the relationship between VIGI, VIG and the U.S. dollar index. As can be seen from the chart, both VIGI and VIG have an inverse correlation with the U.S. dollar index. The degree of impact of U.S. dollar index on VIGI is much greater than VIG.

Should you invest in VIGI?

For long-term investors seeking both dividend and capital appreciation, we do not think VIGI is the best choice, as it clearly underperformed its peer VIG. Not only that VIGI has underperformed in the long run to its peer, it is also more vulnerable in a bear market or when there is macroeconomic uncertainties. In a bear market such as the one last year, VIGI is also being impacted by the strengthening U.S. dollar. Even in an economic recession when the Federal Reserve is forced to drop the rate, VIGI will likely not perform much better, as global money usually flow from non-U.S. markets to buy U.S. treasuries. Unless you absolutely want exposure to the foreign market, otherwise we do not see the need of owning VIGI. VIG or DGRO are clearly better choices than VIGI. Even if you do need exposure to non-U.S. markets, we think VIG or DGRO provides enough exposure. For example, VIG's top holdings such as Johnson & Johnson ( JNJ ), Microsoft ( MSFT ), Visa ( V ), Mastercard ( MA ), and Coca-Cola ( KO ) all have a high exposure to non-U.S. markets.

Investor Takeaway

VIGI no doubt has a portfolio of quality international dividend stocks. However, as we have analyzed in our article, we prefer U.S. large-cap dividend growth ETFs as they have better long-term growth potentials and likely less downside risk. Since 2023 is going to be a year full of macroeconomic uncertainties, we think investors may want to seek other alternatives instead.

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