SCHY: Good Methodology But Wait For The Right Environment

The Schwab International Dividend Equity ETF (NYSEARCA:SCHY) is based on the same core security selection criteria as the successful Schwab U.S. Equity Dividend ETF (SCHD). With a limited operating history, it is difficult to draw conclusions on the SCHY exchange-traded fund (“ETF”).

So far, it appears the SCHY ETF is lagging the SCHD ETF, as the U.S. market has simply outperformed international markets. If a replay of the early 2000s were to occur, I would expect their roles to reverse.

Fund Overview

The Schwab International Equity Dividend ETF provides low-cost exposure to high quality non-U.S. companies that pay high and growing dividends. The SCHY ETF charges an expense ratio of 0.14% and has approximately $540 million in assets. SCHY has an inception date of April 29, 2021.

Strategy

The SCHY ETF tracks the Dow Jones International Dividend 100 Index (“Index”), an index designed to measure the performance of non-U.S. high dividend yielding stocks that have a record of consistently paying dividends for more than 10 consecutive years. To qualify for the index, companies must have minimum float-adjusted market cap of $500 million US dollars. Real estate investment trusts (“REITs”) are excluded from the index.

Eligible stocks are ranked based on four fundamental factors – cash flow to total debt, return on equity, indicated dividend yield, and 5-year dividend growth. Finally, a volatility filter is applied to the top 400 ranking securities to select the top 100. Individual stocks are capped at 4% weight and sectors are capped at 15%. Single country exposure is also capped at 15%. The index composition is reviewed annually and rebalanced quarterly.

The SCHY is the international sibling of the much touted Schwab U.S. Equity Dividend ETF.

Portfolio Holdings

Figure 1 shows the characteristics of the SCHY portfolio. SCHY’s portfolio has a Price-to-Earnings ratio of 10.7x and Price-to-Cash Flow ratio of 5.7x. According to Morningstar, SCHY is considered a large-cap value fund.

Figure 1 – SCHY portfolio characteristics (schwabassetmanagement.com)

Figure 2 shows SCHY’s sector and geographical allocation. SCHY is a defensively positioned fund, with Consumer Staples, Communications, Utilities, and Healthcare accounting for 51.0% of its portfolio. Growth sectors such as Technology and Consumer Discretionary only account for 6.5% of the fund.

Figure 2 – SCHY sector and geographical allocation (schwabassetmanagement.com)

The SCHY ETF is primarily invested in non-U.S. developed countries such as the U.K., Australia, Japan, and Europe. Emerging market exposure is fairly limited.

Returns

With an inception date of April 29, 2021, the SCHY ETF has limited operating history. Figure 3 shows SCHY’s limited returns history. YTD, the fund has returned -9.8%, slightly underperforming the Morningstar category of Foreign Large Cap Value Funds.

Distribution & Yield

The SCHY ETF pays a trailing 12-month distribution of $0.82 / share or 3.7% yield (Figure 4). This is considered high for ETFs, and Seeking Alpha gives SCHY a A- grade for its yield. SCHY’s distribution is paid semi-annually and the most recent distribution amount of $0.5855 was paid on December 12, 2022.

Figure 4 – SCHY distribution (Seeking Alpha)

SCHY vs. SCHD

Readers should note that I hold the SCHD ETF in my personal portfolio, as it scores the best across a broad array of metrics I look at. My latest article on the SCHD can be found here.

I have very high hopes for the SCHY ETF, as it is based on the same core selection criteria (cash flow to debt, return on equity, indicated dividend yield and 5-year dividend growth) as the SCHD, my favorite dividend growth fund.

However, comparing between the SCHY and SCHD, there are some notable differences between the two funds’ composition and returns.

Looking at Figure 1 and 2 above, we can see SCHY ETF’s portfolio skews towards large cap value, as its stocks tend to be low P/E and defensive. However, if we look at the SCHD’s sector allocation, we can see that the SCHD is much “growth-ier,” with a 21.1% allocation to Technology and 6.6% allocation to Consumer Discretionary (Figure 5). SCHD’s defensive sector allocation is likewise much lower, at 32.3% vs. 51.0% for SCHY.

Figure 5 – SCHD sector allocation (schwabassetmanagement.com)

Despite SCHD’s growthier sector allocation, it has actually outperformed the defensive SCHY, in a year where growth stocks have generally underperformed due to their high duration nature. The SCHD has a YTD return of 0.2% to November 30, 2022 vs. -9.8% for SCHY (Figure 6).

Figure 6 – SCHD returns (schwabassetmanagement.com)

I believe the reason behind SCHD’s outperformance vs. SCHY is mainly due to the fact that the U.S. market continues to lead the world in terms of performance. When one fishes in a well-stocked pond, one tends to have better results.

U.S. Continues To Outperform The World

As I have written in a recent article on the Vanguard Total World Stock ETF (VT), the U.S. market continues to outperform the rest of the world due to a number of structural reasons. For example, the U.S. economy still has one of the fastest growth rates in the world, with Q3/2022 GDP growth of 3.2% vs. Europe, which barely grew 0.2% YoY.

Secondly, in times of market volatility like what we have seen in 2022, global investors flock to safe haven assets and countries like the U.S. This has benefited the U.S. dollar and the U.S. equity markets.

Finally, on an individual security level, the U.S. market continues to host the most innovative and dominant companies like Apple and Microsoft, which has driven its outperformance.

Watch For An Inflection Point

However, the U.S. market’s outperformance is not pre-destined. In the early 2000s, the World, represented by the MSCI World Index, significantly outperformed the U.S. market, represented by the S&P 500, from 1999 to 2008 (Figure 7).

S&P 500 vs. MSCI World Index — Figure 7 – S&P500 vs. MSCI World Index (Author created with price chart from stockcharts.com)

This was because the U.S. market suffered from the bursting of the tech bubble and the world benefited from the rise of China and other emerging markets.

If a similar scenario were to occur, for example, if India becomes the next global growth story, we may see international companies outperform their U.S. counterparts, and the SCHY outperform the SCHD.

Conclusion

The SCHY ETF is based on the same security selection criteria as the successful SCHD ETF. It is difficult to draw conclusions on the SCHY ETF, as it has less than 2 years of operating history. However, so far, the SCHY ETF appears to lag the SCHD, as the U.S. market simply has more outperforming stocks.

I would monitor global macro developments for a replay of the early 2000s where international companies outperform U.S. ones. If that scenario were to occur, I believe the SCHY ETF would outperform the SCHD ETF.