Do High-Quality International Stocks Have A Place In Your Portfolio?

Nokia NYSE: NOK, AstraZeneca NASDAQ: AZN and ASML Holding NASDAQ: ASML are among the most popular non-U.S. developed-market stocks. 

So far in 2021, all three are outperforming the S&P 500, the most widely used benchmark for large-cap domestic stocks. Their gains are: 

• Nokia: 43.22%
• AstraZeneca: 15.46%
• ASML: 41.27%
• S&P 500: 15.20%

Professional investors understand that balance is crucial in a long-term portfolio. That balance includes several asset classes, including stocks from non-U.S. developed markets. 

In a recent report evaluating prospects for the second half of 2021, brokerage LPL commented on developed international stocks. Analysts wrote, “The improved value-style performance has opened the door for developed international stocks to potentially outperform U.S. stocks for the first time in over a decade. The recovery the U.S. is currently experiencing from COVID-19 still lies ahead for Europe and Japan.”

Wisdom Tree, an exchange-traded fund sponsor and asset manager, also issued a note touting the potential for quality international stocks. By “quality,” Wisdom Tree and others are referring to stocks with growing profitability strong return on equity, return on assets and other measures. Growth investors would add accelerating revenue to that list.

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Wisdom Tree uses its International Quality Dividend Growth Fund BATS: IQDG as the barometer for international quality. The fund launched in 2016 and has outperformed its benchmark, the MSCI EAFE index over the past year, and has tracked its index closely on a three-year and five-year basis. 

The MSCI EAFE index tracks large- and mid-cap equities across 21 developed market countries, excluding the U.S. and Canada. Since 2018, the S&P 500 outperformed the MSCI EAFE index, but if LPL and Wisdom Tree are correct, that may change.

Wisdom Tree points out that the underperformance since 2018 was due to rallies of lower-quality stocks not tracked in the index. As Wisdom Tree notes, “Lower-quality stocks should trade at a valuation discount to the broader market because they’re assumed to be riskier. Therefore, they should offer more compensation from a total return perspective to entice investors to own them.”

But the situation may be flipping, when it comes to international. Wisdom Tree notes that the “quality factor” means international stocks with strong fundamentals and balance sheets are now available at a value.

Another fund tracking high quality international stocks is the Vanguard International Dividend Appreciation ETF NASDAQ: VIGI.

The fund focuses on high-quality companies boasting steady dividend growth, likely to appreciate in price over the long haul. 

It currently tracks the Nasdaq International Dividend Achievers Select Index, but plans to switch to the S&P International Dividend Growers Index this quarter.

Both indexes capture the performance of stocks that increased dividends for a minimum of seven years in a row, and eliminate companies likely to slash dividends. 

The top three components within the fund, and their year-to-date returns are:

• Nestle OTC: NSRGY: 5.87%
• Roche Holding OTC: RHHBY: 12.51%
• Novartis NYSE: NVS: -1.83%

In general, the high-quality stocks tracked by this ETF outperform the broader market during downturns, but as three-quarters of stocks follow the broader market’s trend, no equity fund should be treated as a hedge against corrections.

In fact, as U.S. markets plummeted Monday, the MSCI EAFE index fell slightly more. 

Nonetheless, international diversification should be a key component of any investment strategy, but it’s imperative to understand which types of securities belong in your portfolio, and which may not. 

One way to protect your portfolio against downturns is with a focus on dividend payers, which contribute to the total return even amid a price decline. 

The dividend-paying portion of your portfolio may tend to be value-focused, as many growth stocks reinvest profit back into new projects, rather than returning the payout to investors. In the decade between 2000 and 2009, international value, along with several other asset classes, outperformed the S&P 500. Lest you think that’s long in the past and nothing to concern yourself: There’s nothing saying that kind of situation can’t happen again.