[This ETF Industry Perspective is sponsored by FlexShares.]
Boosted by consumer spending and confidence, U.S. stock prices continue to rise, and market capitalizations for U.S. equities have climbed to historical highs. We believe now is a great time to consider looking abroad for further upside potential.
As the global economy continues to strengthen, your clients’ portfolios could reap benefits from strategic exposure to international markets. Our analysis shows there may be an increasing number of appropriate investments worldwide for investors to consider. We believe an expanded opportunity set may offer diversification, growth and potential inflation hedging.
Despite the strength of the U.S. equities market, we believe there may be a number of possibilities looming on the horizon. Legislative uncertainty surrounding tax reform and health care could ultimately pose a potential threat to consumer confidence. In contrast, other advanced economies appear to be moving beyond the troubles of the recent past, such as Greece's financial crisis and Brexit. Earnings across Europe, Australia and the Far East (known collectively as the "EAFE" region) are 40% below their historical peaks, leaving room for growth.1
Our analysis shows that, historically, the typical route for U.S. investors seeking to expand their portfolios internationally has been through large-cap investing. Investing in midcap and small international firms, however, may widen possibilities for both diversification and total return benefits.
We believe it is important to go beyond measuring the size of an organization through a simple market-capitalization measurement, and also search for quality or value through other ratios such as a low price-to-earnings ratio. The price-earnings ratio is the ratio for valuing a company that measures its current share price against the per-share earnings.
When considering international dividend stocks, however, we believe investors should consider going beneath the surface to answer critical questions: Can a firm sustain growth over time? Is the payout well-covered? Historical returns do not assure future performance, but a “yes" to both questions may indicate the dividend being paid today may be sustainable over the longer term.
We believe the key is to examine the core financial health of the company to see how its overall financial and organizational condition stacks up. Investors may want to consider an “apples-to-apples" comparison across like firms in a particular region or sector.
Getting to that comparison hasn't always been simple, but the indexes that are foundational for the FlexShares International Quality Dividend suite (IQDF, IQDE & IQDF) of exchange-traded funds (ETFs) use a proprietary Dividend Quality Score (DQS) that we believe helps the funds’ portfolios understand the financial prospects for an organization to continue paying a dividend over the long term.
As the global economy has continued to increase, investors have begun to ask whether inflation may follow. Natural resources provide the potential advantage of offsetting some of the longer-term inflationary effects of economic expansion. Continued and increased spending has driven U.S. growth. It remains to be seen whether the U.S. dollar will heat up beyond the comfort of the U.S. Federal Reserve. Having some nondollar assets in your portfolio may prove to be a useful tactic against domestic inflation.
Our opinion is that broader inflation, however, appears low worldwide, and that there is still room for expansion across many of the advanced economies. Therefore, we believe that if the Federal Reserve pursues a tightening policy, other developed economies' central banks may likely take a slower, tactical approach to rein in the post-financial crisis stimulus initiatives.
The emerging markets historically have not been without their challenges. But we believe that over the long term, underinvestment within the natural resources sector within these countries will eventually pressure supply. Investing in diverse emerging markets' upstream natural resources may allow investors to reap the benefits of rises in demand and yet may also lower exposure to the U.S. dollar.
Getting The Upper Hand
The structural advantages of a global approach may help meet long-term portfolio objectives. Investors still need the best tools to take full advantage of the possibilities. We believe it is important for investors to evaluate their international investing options carefully, and we invite you learn more about several alternatives in our new guide, Scenario Planning: Preparing for International Growth.
1 James McDonald & Daniel Phillips. “The Other Half: Non-U.S. Markets Move to the Fore.” Northern Trust, July 7, 2017.
Before investing, carefully consider the FlexShares investment objectives, risks, charges and expenses. This and other information is in the prospectus and a summary prospectus, copies of which may be obtained by visiting www.flexshares.com. Read the prospectus carefully before you invest. Foreside Fund Services, LLC, distributor.
An investment in FlexShares is subject to numerous risks, including possible loss of principal. Fund returns may not match the return of the respective indexes. The Funds are subject to the following principal risks: asset class; commodity; concentration; counterparty; currency; derivatives; dividend; emerging markets; equity securities; fluctuation of yield; foreign securities; geographic; income; industry concentration; inflation-protected securities; infrastructure-related companies; interest rate/maturity risk; issuer; large cap; management; market; market trading; midcap stock; MLP; momentum; natural resources; new funds; nondiversification; passive investment; privatization; small-cap stock; tracking error; value investing; and volatility risk. A full description of risks is in the prospectus.
FlexShares International Quality Dividend Index Fund (IQDY), FlexShares International Quality Dividend Defensive Index Fund (IQDE) and FlexShares International Quality Dividend Dynamic Index Fund (IQDY) are passively managed and use a representative sampling strategy to track the Underlying Index. Use of a representative sampling strategy creates Tracking Risk where Funds’ performance could vary substantially from the performance of the Underlying Index. Additionally, the Funds are at increased Dividend Risk, as the issuers of the underlying stock might not declare a dividend, or the dividend rate may not remain at current levels. The Funds are also at increased risk of Industry Concentration, where they may be more than 25% invested in the assets of a single industry. The Funds may be more susceptible to adverse economic, market, political or regulatory occurrences affecting that country, market, industry, sector or asset class. Finally, the Funds may also be subject to increased Volatility Risk, where volatility may not equal the target of the Underlying Index.