SCHY: Globally Diversified ETF With Low Risk And Solid Portfolio (NYSEARCA:SCHY)

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~ by Snehasish Chaudhuri, MBA (Finance)

The Schwab International Dividend Equity ETF (NYSEARCA:SCHY) is a diversified global exchange traded fund (ETF) offering low but positive yield in a bearish market condition. It selects high dividend paying stocks in various equity markets outside the United States. These stocks are selected through fundamental analysis, which creates multiple filters in order to find out quality companies. Investing internationally allows investors of SCHY to spread their investment base, target the world’s best dividend paying stocks, diversify their risks, and reduce home bias. In my opinion, investors should hold this ETF for the long term in order to make good returns when the market is bullish, and minimize their loss in adverse market conditions.

The Schwab International Dividend Equity ETF

Schwab International Dividend Equity ETF was formed less than 18 months back. It seeks to track the performance of the Dow Jones International Dividend 100 Index, which measures the performance of high dividend yielding stocks issued by companies in developed and emerging countries outside the United States. SCHY is trading at a marginal discount to its net asset value (NAV), and has an asset under management (AUM) of $431 million. The best thing about this ETF is its extremely low expense ratio of 0.14 percent. Despite that, the selection of stocks in SCHY’s portfolio is quite intelligent and is expected to deliver strong returns.

As described in the prospectus of SCHY:

No single stock can represent more than 4.0% of the index, no single sector, as defined by the index provider, can represent more than 15% of the index, and stocks from countries identified as emerging markets by the index provider cannot represent more than 15% of the index, as measured at the time of index construction, reconstitution and rebalance. The index composition is reviewed annually and rebalanced quarterly.

Due to such sectorial and market ceiling, this fund by default gets fully diversified, and is less susceptible to performance of a particular stock market or industry segment.

SCHY’s Portfolio is Quite Different from US based Diversified ETFs

A globally diversified portfolio is quite different from a US based diversified ETF with respect to sectoral allocation of funds. While we have witnessed a significant concentration of technology, healthcare, energy, real estate, and consumer cyclical stocks in US based diversified ETFs, SCHY has allocated less than 18 percent in those 5 sectors. On the other hand stocks from the core economic sectors like materials, communication services, utilities, and industrials, accounted for more than half of its portfolio. Consumer staples and financial services account for another 30 percent of SCHY’s portfolio.

There is a visible trend in the process of stock selection, which resulted from its multi level filtering and fundamental analysis. Most financial, consumer cyclical, utilities and industrial stocks are selected from developed economies, whereas companies from emerging economies have presence in telecommunication services and consumer staples. While healthcare stocks are selected from European markets, energy companies are selected from the Indian market, where these companies enjoy some kind of oligopoly. When it comes to information technology, the fund has put its bet on Taiwanese companies. When it comes to materials, companies from Taiwan, Australia, and Saudi Arabia make the cut.

No doubt, the portfolio is selected quite wisely, irrespective of how it performs in the short run or within this bearish market. I am an admirer of the portfolio selection process of Charles Schwab Investment Management, Inc., that I earlier witnessed in the case of Schwab U.S. TIPS ETF (SCHP) and Schwab U.S. Dividend Equity ETF (SCHD). The portfolios of both SCHP and SCHD are less risky and generate steady yields, and SCHY is not going to be any exception. As SCHY is not even 18 months old, drawing a conclusion on its yield performance will be meaningless. However, its benchmark index does generate a strong current income. With regard to this, I’d like to mention SCHY’s process of stock selection.

As mentioned in the prospectus documents of SCHY, eligible companies “must have sustained at least 10 consecutive years of dividend payments, have a minimum float-adjusted market capitalization of $500 million USD initially ($400 million USD for those stocks already in the index at reconstitution) and must meet minimum liquidity criteria. Eligible stocks are ranked based on four fundamental characteristics – cash flow to total debt, return on equity, indicated dividend yield and 5-year dividend growth rate – to select the top 400 highest ranked securities by composite score. A volatility screen is then applied to those 400 highest ranked securities, from which the 100 securities with the lowest volatility are included in the index.”

Performance of SCHY’s Portfolio Over the Past 12 Months

Schwab International Dividend Equity ETF holds 104 stocks, out of which 22 stocks consist of almost 70 percent of its total portfolio. I compared the return of these 22 stocks over the past 1 year. There are a few sectors, like telecommunication, materials, consumer Staples, that performed reasonably well, whereas the stocks of financial, utilities, and industrial sectors failed to generate positive growth. Japanese telecommunication giants Nintendo Co., Ltd. (OTCPK:NTDOY) (7974.T) and KDDI Corporation (OTCPK:KDDIY) (9433.T) grew by at least 20 percent. The same is true for Australian mining giants BHP Group Limited (OTCPK:BHPLF) (BHP.AX) and Rio Tinto Group (RIO) (RIO.AX). Consumer Staples stocks like Unilever PLC (UL) (ULVR.L), British American Tobacco p.l.c (BTI) (BATS.L) and Koninklijke Ahold Delhaize N.V. (OTCQX:ADRNY) (AD.AS) also registered positive returns. Big Pharma GSK plc (GSK) (GSK.L) grew by 7 percent, while Roche Holding AG (OTCQX:RHHBY) (ROG.SW) fell by 7 percent.

Stocks of Australian Consumer cyclical firm Wesfarmers Limited (OTCPK:WFAFF) (WES.AX) fell by almost 15 percent. The Toronto-Dominion Bank (TD) (TD.TO), Allianz SE (OTCPK:ALIZF) (ALV.DE), The Bank of Nova Scotia (BNS) (BNS.TO), Zurich Insurance Group AG (OTCQX:ZURVY) (ZURN.SW) and China Construction Bank Corporation (OTCPK:CICHY) (0939.HK) – all generated negative returns. Industrial stocks like Deutsche Post AG (OTCPK:DPSTF) (DPW.DE), KONE Oyj (OTCPK:KNYJF) (KNEBV.HE), and SGS SA (OTCPK:SGSOF) (SGSN.SW) – all recorded huge negative growth – in excess of 26 percent. However, BAE Systems plc (OTCPK:BAESF) (BA.L) grew by an astonishing 41 percent. Utilities stocks were the worst performers, as Enel SpA (OTCPK:ENLAY) (ENEL.MI), E.ON SE (OTCPK:EONGY) (EOAN.DE), and SSE plc (OTCPK:SSEZF) (SSE.L) lost by 35 percent, 21 percent and 2 percent respectively. Incidentally, SCHY has not invested more than 1.5 percent of its fund in any technology, energy or real estate stock.

Investment Thesis

The Schwab International Dividend Equity ETF has been launched very recently, and thus it’s futile to analyze its performance till date, especially when the overall market is bearish. In the long term, the strength and efficiency of its portfolio will be the most determining factor. The rationale and process of selecting stocks in its portfolio makes sense. One may argue that this process is more statistical, and has less scope for judgment. But, the sectorial and market ceiling make this fund fully diversified, and thus is less susceptible to performance of a particular stock market or industry segment. An extremely low expense ratio makes SCHY even more attractive.

An analysis of the top 70 percent of its investments validates this too. Over the past 1 year, while stocks from financial, utilities, and industrial sectors failed to generate positive growth, the stocks from telecommunication, materials, consumer Staples, have generated strong returns. The portfolio also emphasizes selecting stocks of a particular sector from particular economies, where those sectors have flourished. Selecting IT stocks from Taiwanese market, and Materials stocks from Australian market is a case in point. This extreme level of diversification (along with specialization) makes this portfolio less risky and more efficient.

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