Dividend-focused global equity ETFs have lagged the MSCI World Index in the past three years, largely driven by the rising US bond yields after the Federal Reserve’s interest-rate hikes. During this period, the US two-year Treasury yield has gone up from 0.65% to around 2.50%, and this has made already expensive dividend stocks less financially attractive from a risk/reward perspective. In addition, Morningstar analysts argue that global dividend equity ETF investors have suffered from a structural underexposure to technology companies.
To gain a better understanding of the key drivers of returns, we have compared the performance of the Morningstar Developed Markets Dividend Yield Focus Index, which we use as a good proxy for global dividend equity benchmarks, with that of the MSCI World Index.
Performance attribution analysis shows that the negative impact from US dividend stocks – by far the largest country exposure in developed-markets portfolios – contributed more than half of the drag. Dividend stocks such as General Mills, Procter and Gamble and Invesco were among the largest detractors. Meanwhile, relative losses from traditional dividend-paying sectors such as consumer staples and utilities were minimal. By contrast, sectors such as materials and energy underperformed more significantly.
The analysis shows that the technology sector was also a considerable detractor. Tech stocks have experienced tremendous growth during the past three years, outpacing the broad US stock market by more than 7% annualised. However, dividend-focused indexes generally shy away from most technology companies.
The tech sector is mostly associated with growth stocks, and only a minority are companies with mature business models and stable cash flow generation that allow for regular dividend-paying policies and thus inclusion in dividend-focused indexes. Among these established companies we find the likes of Microsoft, Qualcomm, and Intel.
How Morningstar-Rated Funds Stack Up
Of the global dividend ETFs we rate, Vanguard FTSE All-World High Dividend Yield (VHYD) is the only one that has a Morningstar Rating of Gold, Silver or Bronze, and this performed best.
This was followed by iShares STOXX Global Select Dividend 100 (ISPA) and Xtrackers STOXX Global Select Dividend 100 (XGDD). Lyxor SG Global Quality Income (SGQP) came last and also underperformed the average opponent in the global equity income Morningstar Category. The iShares, Xtrackers, and Lyxor ETFs are rated Neutral.
The divergence in performance is largely due to the way these ETFs' underlying indices are constructed, which translates into significant differences in sector exposures.
While the Bronze-Rated Vanguard fund favours broad-based representation, the Lyxor fund comes with a more concentrated portfolio that aggressively overweights certain sectors. It overweights energy, telecom services, and utilities by more than 10% each, while it underweights technology by close to 20% and excludes financials altogether.
The STOXX-tracking iShares and Xtrackers ETFs also favour energy, telecom, and utilities at the expense of technology, albeit to a lesser extent. However, they both include financials.
When assessing dividend index strategies, we favour those that take measures to minimise the risks that arise from investing in higher-yielding stocks.
Vanguard FTSE All-World High Dividend Yield tracks an index that weights by market cap the higher yielding half of the FTSE All-World Index. This simplistic approach might not always offer the highest yield, but it diversifies risks well and ensures a more balanced representation across sectors, in our view
The iShares and Xtrackers funds track the STOXX Global Select Dividend 100 Index. This index selects a fixed number of stocks from the North American, European, and Asian regions and weights them by dividend yield. In our view, the structural biases and lack of diversification of this approach can result in worse performance.
The strategy followed by Lyxor SG Global Quality Income is built on the premise that the best dividend stocks are highly profitable, operationally efficient, and less likely to face solvency issues. In our view, this makes the fund prone to outsize bets.
Income-Seekers Look to Government Debt
Global dividend index strategies have underperformed the broad equity market for the past three years. With US interest rates on the rise, the yield gap between US Treasuries and dividend stocks has narrowed significantly, and this has drawn income-seeking investors back to the comparative safety of government debt. Moreover, technology stocks, to which most dividend equity indexes are structurally underexposed, have done tremendously well.
Within the group of dividend ETFs rated by Morningstar, we observe divergences in performance, as they follow diverse index strategies. In our view, the strategy that maximises diversification among sectors is better placed to outpace the others over the long term.
