For most American income investors, the equity income portion of their portfolio consists almost entirely of shares of U.S.-based large cap dividend payers. There are good reasons for this. The low-risk consistency and reliability that income investors crave are most often found in such investments. Contrast this with a typical equity growth portfolio. Most financial advisors would recommend investing a significant percentage of a growth portfolio in international equities. I’ve seen recommendations for an international equity allocation as high as 30%, and even 40%.
One reason that dividend investors tend to avoid holding international stocks in their portfolios is that they believe the U.S.-based multinationals in which they are invested already provide adequate exposure for international diversification through the revenue streams those companies derive overseas. Although it is true that they are getting some international exposure, what one has to keep in mind is that not all international exposure is equally desirable. In fact, in the current economic environment, some types of international exposure will likely prove detrimental to corporate earnings and may put pressure on dividends. Specifically, companies deriving income from countries whose currencies are weakening with respect to the U.S. dollar can expect profits to be adversely affected.
Currency Outlook and Risk
From analyses that I have read, many forecasters are anticipating interest rates in the U.S. to eventually start moving up over the next year. This is expected to lead to the value of the U.S. dollar rising against the currencies of other countries whose economies continue to struggle, particularly against the Euro, Pound, and Yen. As commodity prices are expected to remain under pressure, the currencies of countries whose economies are highly dependent on oil and other commodities are also expected to weaken against the U.S. dollar. These include currencies from such countries as Canada, Norway, and Australia.
Companies that have significant overseas revenues coming from these countries can be expected to take a hit to their bottom lines starting next year. Conversely, companies with income from countries whose currencies are expected to increase in value against the U.S. dollar will benefit from the tailwind provided by the currency exchange and will be in a stronger position to maintain and increase dividends.
So what countries are expected to have currencies that outpace the U.S. dollar? After reading what various forecasters are saying, I have concluded that the countries to have currencies that will most likely do well against the U.S. dollar are China and Mexico.
International Dividend Opportunities
China and Mexico have low-cost labor and large manufacturing bases that will continue to make them attractive production centers. Capital inflows can be expected to boost the GDP of these countries in the coming year and lead to yuan and peso appreciation against the dollar. To exploit this possible opportunity, I searched for good equity investments from these two countries that would pay decent dividends. Although I found several excellent potential Mexico-based investments, none of them paid a dividend that I consider to be high enough to qualify them as good income investments. China, however, presented a different story.
One income-oriented equity investment that I find particularly attractive is a WisdomTree ETF – the China Dividend Ex-Financials Fund (CHXF). With a distribution yield of 5.79% and an expense ratio of 0.63%, this fund has exhibited the characteristics of a good equity income investment. In the 14 months of CHXF’s existence, its price has generally moved in sympathy with larger index-based ETFs, like FXI, but with less volatility. The fund also avoids holding shares of the shady Chinese banking stocks that I believe are too heavily overweighted in other ETFs.
Another potentially smart investment for income that I ran across is the Taiwanese communications company Chungwa Telecom Company (CHT). While the telecom business in Taiwan is extremely competitive, CHT’s expanding business on the mainland and elsewhere make its earnings prospects attractive. The company’s stock currently has a dividend yield of 4.92%.
Let me leave you with a couple of thoughts to consider:
- In emerging markets, corruption and weak corporate governance are part of the investing landscape. Many publicly traded corporations are majority-owned by wealthy families who may or may not have the best interests of other investors in mind. What these families almost always want to do, however, is extract money from the corporate entities that they own. In many cases, their preferred way of doing this is through dividend payments. In China, there is a special case of this wherein the “wealthy family” is in fact the government (in the case of state-run enterprises) and its communist overlords. They too extract income through dividends. And when they want more income, they raise the dividends. That is why some investors actually consider some Chinese dividend payers to be good dividend growth picks. I wouldn’t go that far, but suffice it to say that if the central government has a stake in the well-being of some of your investments (as they do in many of the CHXF holdings), then the dividend payouts from those investments will have a certain degree of protection not available elsewhere.
- As attractive as these opportunities may look, disciplined allocation is still a must when investing internationally. I personally would never concentrate more than 10% of my equity income portfolio in any one country outside the U.S., and that includes China.
So don’t shy away from looking at international equity opportunities, just be sure to do your homework.
(Disclosure: I do not currently own either of the investments mentioned, but may purchase them in the future. Yields mentioned are current as of 11/15/13. I am not recommending the investments discussed above for purchase, but only that they may be potential candidates for your own research. Please read the prospectuses for any investments prior to making your own investments.)
Update: In July 2015, Wisdom Tree converted the CHXF fund into CXSE China Ex-State-Owned Enterprises Fund. See this article for details.)