Can the Vanguard International High Dividend Yield Index Fund ETF Shares Outperform Again in 2026?

For more than a decade, American investors who ventured abroad were punished for their diversification. International stocks trailed U.S. equities in 13 of the 17 years following the 2008 financial crisis, as American growth stocks dominated global returns, turning "U.S. exceptionalism" into Wall Street gospel.

Then 2025 happened -- and one exchange-traded fund (ETF) delivered a stunning exception. The Vanguard International High Dividend Yield Index Fund ETF Shares (NASDAQ: VYMI) returned 29.6%, nearly doubling the S&P 500's 15.6% gain.

Now, investors face the inevitable question: Can the fund do it again in 2026?

The case for international value

Understanding what drove 2025's outperformance is essential to handicapping next year. The fund tracks the FTSE All-World ex-US High Dividend Yield Index, holding more than 1,500 dividend-paying stocks across developed and emerging markets -- excluding the United States. That positioning proved fortuitous as several macro forces converged.

European stocks surged on the back of Germany's historic fiscal pivot. After years of austerity, Europe's largest economy announced plans for infrastructure and defense spending valued at roughly $1.3 trillion over the next decade.

European banks -- which comprise a significant portion of the fund's 42% financial services allocation -- saw return on equity climb from single digits to low double digits as interest rates normalized. Holdings like HSBC Holdings, Novartis, and Shell likely benefited from these trends; however, isolating their exact contribution to the fund's return is challenging.

The weakening dollar amplified these gains for U.S. investors. When foreign currencies strengthen against the U.S. dollar, returns on unhedged international investments receive an automatic boost -- and 2025 delivered the dollar's worst first-half performance since 1973.

Built for income, priced for value

Beyond the macro tailwinds, the fund's construction deserves credit. The expense ratio sits at just 0.17%, among the cheapest in its category. The dividend yield hovers near 4%, more than double the S&P 500's roughly 1.5%. And at a price-to-earnings ratio of around 13, the fund trades at a notable discount to U.S. large-cap growth stocks -- though that gap can shift quickly.

Market-cap weighting pushes the portfolio toward larger, more stable dividend payers -- reducing the risk of yield traps where high dividends signal distress rather than generosity. That tilt is evident in the top holdings: Nestlé, Toyota Motor, Roche Holding, and Royal Bank of Canada are precisely the kind of entrenched multinationals unlikely to slash their payouts.

The 2026 question mark

Can the fund replicate the magic of 2025? Several catalysts could extend the run. NATO members have pledged to increase defense spending to 4% of their gross domestic product (GDP) by 2035, potentially keeping European defense and industrial stocks in high demand.

International dividend stocks generally trade at lower price-to-earnings multiples than U.S. growth equities -- a gap that could narrow further if sentiment continues shifting. And if the Federal Reserve cuts rates while European central banks hold steady, continued dollar weakness could provide another tailwind.

But risks loom large. The fund's 42% allocation to financial services creates concentration risk if bank earnings disappoint or loan growth stalls. Tariff uncertainty could weigh on export-heavy economies in Europe and Asia.

Currency swings can quickly erode returns for U.S. investors. And the simple math of mean reversion suggests that 2025's outperformance may have borrowed some returns from future years.

The diversification dividend

Perhaps the most honest answer is that trying to predict whether international stocks will beat U.S. stocks in any given year is a fool's errand. What's more certain is that holding some international exposure reduces portfolio volatility over time, since U.S. and foreign business cycles don't move in lockstep.

For investors seeking income and diversification at rock-bottom cost, the Vanguard International High Dividend Yield ETF remains a compelling option regardless of whether 2026 brings another banner year. The 4% yield provides a cushion, the diversified holdings offer stability, and the moderate valuation relative to U.S. growth stocks means expectations are already modest. Sometimes, the best investments are those that don't require everything to go right.

HSBC Holdings is an advertising partner of Motley Fool Money. George Budwell, PhD has positions in HSBC Holdings, Toyota Motor, and Vanguard International High Dividend Yield ETF. The Motley Fool recommends HSBC Holdings, Nestlé, and Roche Holding AG. The Motley Fool has a disclosure policy.