MW This stock fund is fully diversified from the S&P 500 - and pays high dividends

By Philip van Doorn

Adding exposure away from the Magnificent Seven can lower your portfolio risk, and you can earn high dividend yields at the same time

The S&P 500's weighting by market capitalization has led to a small number of companies making up nearly a third of the index - and those few stocks tend to move up and down together. There are various ways for U.S. investors to reduce this concentration at home, but why not add some exposure to non-U.S. economies while earning attractive dividends?

One exchange-traded fund that might be attractive for investors worried about U.S. market concentration and volatility is the Franklin International Low Volatility High Dividend Index ETF LVHI, which tracks an index of stocks in developed economies outside the U.S.

Jeff Silverman, the head of advisory solutions for Franklin Templeton Investment Solutions, explained the fund's strategy during an interview with MarketWatch.

Volatility and S&P 500 concentration

A recent increase in stock-market volatility has resulted from policy announcements from President Donald Trump that can change on a dime. We saw this on Monday when a sharp early decline for U.S. stocks was tempered as the day went on, after the U.S. entered into temporary agreements with Mexico and Canada to delay Trump's planned 25% tariffs by at least a month.

Another recent example was provided by the market on Jan. 27, when shares of Nvidia Corp. fell 17% after news that a Chinese company called DeepSeek had developed competitive artificial-intelligence technology at much lower cost than higher-profile applications such as OpenAI's ChatGPT. For at least one trading session, investors grew concerned about Nvidia's growth path, because the company has dominated the market for graphics processing units being installed by data centers to support the AI-infrastructure build-out.

Those are only two examples of day-to-day volatility, but they might be important to investors who don't want to be overly exposed to the type of decline we saw in 2022, when the S&P 500 SPX fell 18.1%, while the index's information technology sector dropped 28.2%.

All investment-performance figures in this article include reinvested dividends.

Wednesday's Need to Know column: DeepSeek and tariffs have roiled the market. History shows deeper pullbacks are coming, this strategist says.

The $628 billion SPDR S&P 500 ETF Trust SPY tracks the S&P 500 by holding all 500 stocks. But the Magnificent Seven group of tech companies - Apple Inc. $(AAPL)$, Microsoft Corp. $(MSFT)$, Nvidia $(NVDA)$, Amazon.com Inc. $(AMZN)$, Alphabet Inc. $(GOOGL)$, Meta Platforms Inc. $(META)$ and Tesla Inc. $(TSLA)$ - made up 32.4% of the SPY portfolio as of Tuesday.

You might already have been aware of how concentrated the S&P 500 was to the Magnificent Seven. Brett Arends has an effective way of explaining just how concentrated the U.S. large-cap index has become.

You might want to continue with a certain amount of exposure to the cap-weighted S&P 500. After all, its weighting rewards the best performers' momentum, and the strategy has worked out very well over recent years, with low expenses for index funds.

But there are easy ways for investors to diversify within the S&P 500. Analysts at Jefferies argued that an equal-weighted approach might be well suited to current market conditions, which are similar to those that preceded market rallies in 2013, 2017 and 2021. It turns out that in two of those three years, the equal-weighted S&P 500 outperformed the cap-weighted index. You can easily take the equal-weighted approach by investing in the Invesco S&P 500 Equal Weight ETF RSP.

Another way to avoid market-cap weighting while still investing within the S&P 500 is by using exchange-traded funds that weight stocks according to S&P Dow Jones Indices growth or value scores.

Then again, you might also want to add exposure to companies outside the U.S.

Diversification by geography, with lower volatility and a value tilt

The Franklin International Low Volatility High Dividend Index ETF and the in-house index it tracks were both established in July 2016. The fund quotes a 30-day SEC dividend yield of 4.70%. That figure is updated monthly and is meant to be used for comparison of the yield against those of other funds.

As of Dec. 4, the last time the fund underwent its quarterly rebalancing, the fund's actual dividend yield was 5.83%, Silverman said. Dividends are paid quarterly on the same day the fund is rebalanced or reconstituted based on the underlying index, which happens once a year in March.

When the fund's index is reconstituted, the Franklin Templeton team uses a "rules-based approach" that begins with about 3,400 companies in developed markets outside the U.S., Silverman said. The list is narrowed down using a scoring methodology that encompasses earnings estimates, a look back at earnings consistency and an analysis of the companies' ability to maintain their dividend payments. The scoring also factors in stock-price volatility.

The index construction also includes other "complementary factors," Silverman said, as the methodology focuses on "higher-yielding stocks with less downside capture."

"We are not only looking at high-dividend payers. We are looking at the industries they are in, for changes that affect volatility of earnings," he said.

The index and the fund also have limits to avoid overconcentration within regions, countries or industry groups, while individual holdings are limited to 2.5% of the portfolio when it is rebalanced.

The fund's management team also continually applies currency hedges as money flows into the fund, Silverman said. He said other adjustments were made to limit currency risk, based on differences in interest rates in developed economies.

He added that the fund saw net inflows of more than $700 million during 2024. The fund has $1.7 billion in assets under management and is rated five stars (the highest rating) within Morningstar's U.S. Fund Foreign Large Value category.

Here are the largest 10 holdings (out of 139) of the Franklin International Low Volatility High Dividend Index ETF as of Dec. 31:

   Company                             Ticker   Country        Dividend   % of LVHI portfolio 
   Nippon Telegraph & Telephone Corp.  JP:9432  Japan              3.43%                2.60% 
   GSK PLC                             UK:GSK   U.K.               4.42%                2.60% 
   Roche Holding AG                    CH:RO    Switzerland        3.18%                2.52% 
   Rio Tinto PLC                       UK:RIO   U.K.               6.93%                2.47% 
   Canadian Imperial Bank of Commerce  CA:CM    Canada             4.16%                2.44% 
   Bank of Nova Scotia                 CA:BNS   Canada             5.90%                2.43% 
   Enel SpA                            IT:ENEL  Italy              6.22%                2.43% 
   Shell PLC                           UK:SHEL  U.K.               4.19%                2.42% 
   Nestlé S.A.                         CH:NESN  Switzerland        3.87%                2.42% 
   TC Energy Corp.                     CA:TRP   Canada             4.92%                2.38% 
                                                                   Source: Franklin Templeton 

Here is a breakdown of the top 10 countries in which companies in the portfolio are based, compared with those of the fund's benchmark, the MSCI All Countries World x-USA IMI Index XX:664211.

   Country or region    % of LVHI portfolio  % of MSCI World x-USA Index 
   Japan                             14.54%                        22.30% 
   Canada                            13.27%                        11.32% 
   U.K.                              12.45%                        13.14% 
   Switzerland                       11.42%                         7.82% 
   Italy                              9.48%                         2.52% 
   France                             8.15%                         8.88% 
   Australia                          7.87%                         6.82% 
   Germany                            6.13%                         7.50% 
   Singapore                          5.59%                         1.56% 
   Hong Kong                          3.07%                         1.72% 
                                                          Source: FactSet 

Here is a look at how the fund has performed against its benchmark through Feb. 4, as calculated by FactSet, along with performance figures for its Morningstar category. The fund's returns are after expenses, which are currently 0.4% of assets under management.

   Fund, index or category                                            1-year return  3-year avg. return  5-year avg. return 
   Franklin International Low Volatility High Dividend Index ETF              17.5%               12.3%                9.2% 
   MSCI World x-USA                                                           14.5%                9.5%                9.1% 
   Morningstar US Fund Foreign Large Value category                           10.0%                4.4%                6.0% 
                                                            Sources: FactSet (for LVHI and MSCI index returns), Morningstar 

For three years, Morningstar has ranked the Franklin International Low Volatility High Dividend Index ETF in the top 1% in its category, while the fund ranks in the top 2% within the category for five-year performance.

Silverman said his team at Franklin Templeton was focused on working with the firm's advisers and to diversify client portfolios. "International exposure should be a strategic part of asset allocation. A lot of people are moving away from diversification in the U.S.," he said.

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-Philip van Doorn

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February 05, 2025 10:42 ET (15:42 GMT)

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