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By Abby Woodham

Investors have many choices when it comes to dividend-focused international-equity exchange-traded funds. PowerShares International Dividend Achievers (NYSEARCA:PID) is one of our favorites for its quality focus and relatively low volatility. Instead of chasing the highest yield available like many of its competitors do, PID targets durable companies by employing quality screens. This fund is suitable as a small core allocation for investors comfortable with PID’s slight contrarian tilt. This fund can also be used to add to an existing international-equity allocation, as valuations continue to be attractive relative to U.S. equities.

The rationale behind domestic dividend investing applies to foreign equity. Studies show that a strong dividend payout ratio is correlated with higher earnings growth and solid fundamentals. By paying out dividends to investors, managers are forced to use cash responsibly and efficiently instead of going on a buying spree. The opposing view states that holding back cash means managers see opportunities to reinvest in the company to grow future earnings, but the data show that dividend payers outperform nonpaying firms almost all of the time.

PID can be viewed as an international counterpart to popular domestic ETF Vanguard Dividend Appreciation (NYSEARCA:VIG). PID’s methodology is less stringent, as it requires only five years of increased annual dividends to VIG’s 10, and its quality screens are not as rigorous. Despite methodology differences, PID behaves similarly to VIG. Both funds have yields close to the market average (PID’s is currently 2.59%), which might surprise investors expecting a higher yield. Many of PID’s competitors offer yields north of 4%, but these funds are highly contrarian and invest in firms have been beaten down by the market. PID’s portfolio has more of a mix of value and growth names.

PID weights by dividend yield, which boosts income but also includes some risk: Compared with cap-weighted funds, PID’s weighting scheme adds on additional volatility during rough patches in the market. During such periods, high-yielding companies are the unloved bunch and can trade at a significant discount to their fundamental fair value. Buying a yield-weighted fund is a contrarian stance, but one that has been lucrative. When a historically durable company is high-yielding, it suggests that the market is anticipating bland earnings growth or a dividend cut. Going against the grain has been a profitable decision in past years, as a recent study by Morningstar showed that moderately high-yielding stocks beat low-to-zero yield stock consistently without picking up extra volatility. PID has performed particularly well on this front by not targeting the highest-yielding companies.

All these factors add up to a fund that has offered the best risk-adjusted performance of its peer group. PID has exhibited less volatility than has its competitors since inception and better total return than all but iShares Dow Jones International Select Dividend Index (NYSEARCA:IDV). PID has also outperformed the MSCI EAFE Index over all time periods since the 2008 financial crisis with less volatility.

Portfolio Construction
PID tracks the International Dividend Achievers Index, which buys ADRs, GDRs, and common stock that have increased their annual dividends for the past five years and have a trading volume of at least USD 500,000 daily. The index is weighted by trailing 12-month dividend yield, except for Canadian stocks, which are weighted by current dividend yield. To qualify, holdings must trade on the NYSE, NASDAQ, or London Stock Exchange. As such, the starting universe of this fund’s index is somewhat narrow, as many foreign companies are listed only on their local exchanges and not in New York or London. The index is reconstituted annually and rebalanced quarterly. Forty percent of the fund is split between Canada and the United Kingdom, with the rest mostly in developed markets, particularly Europe and Asia. Companies listed as ADRs in the United States are included, but not U.S.-domiciled firms. PID is almost entirely allocated to large-cap stocks. The fund is allowed to engage in securities lending but does so on a very minimal scale. PID's sector weightings are well-diversified: heaviest in energy (21%), telecommunications (15%), and health care (14%), with smaller weight given to several other sectors.

Fees
This fund charges 0.56% a year, which is average for foreign large-value exchange-traded funds but slightly expensive for dividend-focused funds. A portion of distributions is withheld for foreign tax purposes from companies in some countries and the dividend yield figure is net of this tax. Investors can file for a foreign tax credit to offset these taxes but not if the fund is held in a tax-advantaged account. Distributions from PID are currently taxed as qualified dividend income.

Alternatives
IDV holds the 100 highest-yielding companies from the developed world, subject to quality and liquidity screens. It is particularly heavy in Australia and light in Japan. It is slightly cheaper than PID at 0.50% a year and is the only fund to beat PID’s total return since 2008.

SPDR S&P International Dividend (NYSEARCA:DWX) has been particularly popular in 2012, doubling in size to more than $1 billion. Investors have been attracted to its very high yield of just under 7%. DWX is able to provide such high yield because it is a true contrarian’s fund: It weights by yield but without the quality screens used by funds with similar weighting schemes. This means the fund loads up on companies beaten down by the market. Although this fund is cheap at 0.48% a year, it has high portfolio turnover. DWX is over 30% more volatile than PID, and had the worst risk-adjusted performance of the category over the past three years.

WisdomTree DEFA (NYSEARCA:DWM) weights by dividends paid and keeps North America out of the portfolio. If you’re wary of telecommunications and utilities, this fund might be a good alternative, as it is one of the few dividend payers that doesn’t load up on these sectors. DWM is more volatile than PID but also offers more yield and is cheaper with an expense ratio of 0.48% per year.

Another interesting option for international yield is iShares MSCI EAFE Value Index (NYSEARCA:EFV), which is not a dividend-focused fund but still offers more than 4% yield. This ETF zeros in on value stocks from developed countries and actually out-yields PID because of its larger allocation to unloved Europe. EFV charges 0.40% annually, which is on the cheap side.

Disclosure: Morningstar, Inc. licenses its indexes to institutions for a variety of reasons, including the creation of investment products and the benchmarking of existing products. When licensing indexes for the creation or benchmarking of investment products, Morningstar receives fees that are mainly based on fund assets under management. As of Sept. 30, 2012, AlphaPro Management, BlackRock Asset Management, First Asset, First Trust, Invesco, Merrill Lynch, Northern Trust, Nuveen, and Van Eck license one or more Morningstar indexes for this purpose. These investment products are not sponsored, issued, marketed, or sold by Morningstar. Morningstar does not make any representation regarding the advisability of investing in any investment product based on or benchmarked against a Morningstar index.

Source: Favorite International Dividend ETF