The iShares International Select Dividend ETF (BATS:BATS:IDV) contains some solid exposures, even within some of the sectors that are a bit more levered to the macro headwinds. Trading at a low multiple, it seems well priced for the incoming rate hikes and the tectonic effects those have on equity markets and valuations. The income is also very strong. Investors might appreciate the qualities of this ETF, although they should recognise that there are risks, especially volatility risks, associated with the contained sectors. While the discounted multiple perhaps lends itself to longer-term capital protection, investors should generally beware.
Breakdown of IDV
Let’s begin with the sectoral look.
Utilities should be stable if not positively exposed to the extent that the power they generate is not gas-fired. The international exposure of the ETF does put plenty of international utility companies in the bucket, which means solid earnings from either regulated utilities or companies that have already long since initiated major spend on renewable energy generation. With electricity prices being high with the energy crisis, relatively fixed cost production should see earnings growth from here on.
Insurance and banking together account for 29% of the portfolio. They directly benefit from rising rates from higher investment yields and better net interest margins, respectively. 3.66% is in food and tobacco, accounted fully for by the single investment in British American Tobacco (BTI). That puts almost 50% of the portfolio in strong industries that are likely to see earnings growth or at least earnings resilience.
The rest of the exposures are broadly cyclical, and earnings declines can be expected from materials companies (16%) like Rio Tinto (RIO), Fortescue Metals (OTCQX:FSUMF) (OTCQX:FSUGY) or heavy construction like ACS Actividades (OTCPK:ACSAF).
Let’s hone in a bit on the qualities of the ETF. The 7.4% yield is solid, and supported by fundamentals that are now generally favourable, and well within the earnings yield indicating low payout ratios. The earnings yield is almost 20% thanks to the PE ratio just below 5.4x.
The rising rate hikes are changing the fundamental standards by which equities are valued. We believe rate hikes could end at the 6% level, and that those levels may persist for the longer term future. This implies more than a 5% decline long term in earnings annually at fair value. Given the cyclicality of the industry, we think this implication reflects well the late stage of the cycle we’re in and the potential severity of a recession that is brought on by a needed increase in rates.
The 23% decline YTD has brought valuations low, but the multiples in these cyclical industries were low to begin with as markets avoided getting carried away with earnings growth that they viewed as unsustainable. It is therefore reasonable that valuations have become fairer. Expense ratios are also rather modest at 0.49%, which puts it slightly below the iShares average, but it isn’t the typical low cost of value weighted ETFs.
We think it’s possible to find similar or better value than this ETF in markets for single stocks. Less cyclicality and overall better economics can be bought at the same or lower multiples and provide a better margin of safety. Nonetheless, IDV is a nice looking ETF for investors who prefer broader exposures.
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