The essential investor takeaway from the recent Fed press conference is that bond yields are not about to climb higher at least until 2023, which gives companies a meaningful amount of time to load up on cheap debt. Moreover, though the OECD lifted the economic outlook for 2020, it also emphasized that the accommodative policy from central banks (put another way, low rates) will be necessary to prop up the recovery.
Thus, as minuscule or even sub-zero coupons make investors seek alternative income options, the importance of dividends in creating a meaningful and scalable income stream is clearly not about to falter. But the pandemic dented cash flows, and hence, dividend plans for many companies, which previously looked fortified, and the process of picking a stock with a safe, sustainable payout and comfortable yield has become much more taxing.
Today, I continue my series of articles on dividend-focused ETFs with a deep delve into the Invesco International Dividend Achievers ETF (PID), a fund that has a few apparent advantages but also risks and flaws that are not observable upon cursory inspection.
A look under the hood
At the moment, PID’s portfolio encompasses ~$598 million in assets under management with 59 holdings. Its 12-month distribution rate is 4.76%. The fund tracks the NASDAQ International Dividend Achievers Index (DAT). To be included in the index, a company must increase its annual regular payout for at least five consecutive years.
DAT uses a dividend yield weighted methodology. Rebalancing takes place every quarter.
“At each quarter, the Index is rebalanced such that the maximum weight of any Index Security does not exceed 4%. The excess weight of any capped security is distributed proportionally across the remaining Index Securities. The changes are effective after the close of trading on the third Friday in March, June, September and December.”
With an ETF that tracks DAT, investors might benefit from exposure to the global capital markets and stocks with promising dividend growth profiles simultaneously. But before we delve deeper, I should clarify what an adjective “international” stands for in the context of the fund. On page 2 of the DAT Methodology, it is explained that:
“…the issuer of the security must be incorporated outside of the United States and not in a country of beneficial interest as defined by the Nasdaq Global Index (NQGI) methodology.”
The countries of beneficial interest include the Bahamas, Bermuda, Cyprus, Malta, etc.; the full list is available on page 11 of the NQGI Methodology.
But at the same time, the issuer must:
“…be listed on The Nasdaq Stock Market® (Nasdaq®), the New York Stock Exchange, NYSE American, or the CBOE Exchange.”
As a result, the portfolio is dominated by common stocks (31 in total), which are principally Canadian (excluding, for example, Dublin-based Linde plc (OTC:LIN) listed on the NYSE), and ADRs of mostly European companies. It is also worth remarking that PID holds partnership interests in three LPs: Brookfield Property Partners (BPY), Brookfield Infrastructure Partners (BIP), and Brookfield Renewable Partners (BEP). GDRs are in fourth place with only two holdings: Russian steel major Novolipetsk Steel (OTC:NISQY) and Mumbai-based multinational conglomerate company Reliance Industries; both have a secondary listing on the London Stock Exchange.
Low diversification is an Achilles heel
For an investor who seeks an ETF with significant diversification, PID will likely not be a fund of choice because of two essential reasons. First, regarding the country mix, the fund is predominantly focused on Canada and the United Kingdom, which account for 50.65% and 7.53%, respectively. This implies that softness in their economies or FX volatility will likely take a toll on dividends and price returns (and it has already taken).
To rewind, shortly after the Great Recession, the loonie performed much stronger than the greenback; in 2011, the CAD/USD exchange rate even touched 1.05.
But that changed later in the 2010s, partly because lackluster oil prices (due to high sulfur content, low API gravity, and limited takeaway capacity, the Canadian benchmarks like WCS typically trade at a discount to WTI and Brent) led to the depreciation of the national currency. From 2012 to 2016, the loonie has lost almost a third of its value and has been trading rangebound since then (except for April 2020; as investors rushed to safe-haven assets like U.S. Treasuries, the Canadian dollar tumbled).
At the same time, the British pound has been declining almost incessantly since 2014 with a few (failed) attempts to reclaim abandoned heights, as it was battered by Brexit-related uncertainty that clouded the U.K. economic outlook and restrained total returns of PID. The recent news that the Bank of England is exploring sub-zero rates has pushed GBP lower.
Second, the sector allocation is also far from perfect. Combined, Financials and Energy account for ~48.2%, while exposure to Healthcare, which has been shining this year thanks to the short-term stimuli stemming from the pandemic, represents only ~3.26% of the portfolio. Also, PID’s largest holding with a ~4.84% weight is Methanex (MEOH), an unprofitable methanol company that fell out of favor with investors due to tumbling sales.
Beware of the energy sector-related risks
Another issue investors should not ignore is the fund’s exposure to the embattled Canadian oil companies with oil sand assets, which had already been afflicted by cheap oil in 2019 and have encountered a perfect storm this year. PID invested in the following Canadian petroleum heavyweights:
Other PID holdings from the energy sector are as follows:
Created by the author using the Fund holdings dataset.
Bitumen requires hefty capex and has high production costs, which weigh on margins. Moreover, the oil price gyrations meaningfully complicate cash flow generation. Besides, in terms of carbon footprint, oil sand operations are barely clean, which takes its toll on the ESG rating and reduces investor attention to respective companies. Inter alia, on May 13, Norges Bank excluded IMO, CNQ, and SU from the Government Pension Fund Global citing “unacceptable greenhouse gas emissions.”
A deeper look at the performance
Unfortunately, if compared to the overall U.S. market represented by the S&P 500 (SPY), both total and price returns of PID look bleak, no matter what period we are analyzing. For example, the 10-year total return of PID is just 21.12%, while the result the S&P 500 delivered is more than 10x greater. Inter alia, the Vanguard Dividend Appreciation ETF (VIG), a fund that tracks the NASDAQ US Dividend Achievers Select Index, has also delivered a much more appealing total return since 2010.
There might be a plethora of culprits for the weak performance, but I personally consider the depreciation of the Canadian dollar and the British pound vs. the U.S. dollar, and inadequate diversification, the issues I highlighted above, as the essential drivers for underperformance. To bring a bit more context here, I also added the iShares MSCI Canada ETF (EWC) and the iShares MSCI United Kingdom ETF (EWU) charts, which illustrate that my hypothesis is correct: the S&P 500 has easily trounced both.
Finally, if we zoom in the chart and take a look at 1-year returns that have been heavily influenced by the coronavirus crisis, it appears that the respective ETFs again substantially lagged behind the U.S. benchmarks; all three funds have not recovered yet. This fact illustrates that investors are much more confident in the U.S. economic prospects shored up by the accommodative policy of the Fed.
Source: Seeking Alpha
PID did not deliver alpha in the last ten years, as currency headwinds dented its returns. It also lagged behind VIG, its U.S.-focused alternative. The fund is materially overweight in the Canadian equities and has meaningful exposure to the energy sector, which means the performance of the loonie and oil price trajectory remain among the primary drivers of its price returns.
In sum, investors should carefully consider all the risk factors and act with caution.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.