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Dividend Investing Abroad

As investors pile into U.S. dividend-oriented stock funds, it may be time to look farther afield.

Laura Lallos, 06/11/2012

Whether to increase income as interest rates scrape bottom, or to reduce equity risk in a volatile markt, investors in the United States have been in hot pursuit of dividend-paying stocks. Funds such as Vanguard Dividend Growth VDIGXFederated Strategic Value Dividend SVAAX, and Franklin Rising Dividends FRDPX have seen their asset bases burgeon over the past year through May, even as U.S. equity funds overall have lost $125 billion.

Granted, noteworthy domestic dividend-oriented funds are still finding opportunities, and April 3's Fund Spy highlights several such funds. There are more plentiful opportunities abroad, however.

In a recent Morningstar interview, Gerd Woort-Menker, longtime manager of JPMorgan International Value JIESX, observed that there has not been the same rush into foreign dividend-payers. "Compare Royal Dutch Shell RDS.A to Exxon Mobil XOM," Woort-Menker noted. Both global integrated oil-and-gas companies are reliable dividend stalwarts, but Morningstar currently calculates a projected yield of 4.8% for Royal Dutch Shell, as opposed to 2.9% for U.S.-based Exxon Mobil.

That's not an isolated example. Even the bluest chips have been embroiled in the European crisis, and plunging stock prices have boosted yields abroad. Indeed, the average foreign large-cap value fund has a 12-month-yield of 2.9% as of May 31, compared with 1.4% for the typical U.S. large-value fund.

Now may be the time for dividend-oriented fund investors to look to the horizon. Those doing so in taxable accounts should be aware of two quirks detailed in this ETF Specialist. First, many countries require taxes to be withheld before dividends are distributed, and U.S. investors can claim a deduction or credit for those foreign taxes paid. Second, thanks to tax treaties, many foreign dividends are taxed at the qualified dividend rate currently in effect until the end of 2012, but others are treated as ordinary income.

High Yields Spell Opportunity, Not Safety
Another caveat: Yield is not the end of the story. Take SPDR S&P International Dividend DWX. This index exchange-traded fund boasts a dramatic 7.3% 12-month yield, one of the highest among foreign mutual funds and ETFs. The fund is also quite risky, however, as its yield screens don't always exclude distressed companies with plunging prices that push yield up.

Here is where active managers can shine. The managers of Brandes Institutional International Equity BIIEX carefully cull stocks they believe are worth much more than their bargain-basement prices. The fund, which currently yields 5.5%, has held up well in downturns such as 2008 and 2011. But this is a strategy that demands patience from shareholders. For one thing, management's picks tend to cluster in particular countries and sectors, leading to outsized stakes in Japan and communications services, for example. And while the fund has excellent long-term returns, it can fall well behind in rallies.

Causeway International Value CIVIX is a similar story: Its 3.5% yield is a reflection of an almost contrarian stock-picking process. Sarah Ketterer and her team insist on clean balance sheets and seek companies that are either paying dividends or buying back stock. However, they want to buy low. That meant adding economically sensitive materials and industrials stocks during the economic crisis in 2008 and early 2009. While the fund's long-term returns are outstanding, shareholders have had to hold on through some bumpy patches.

Laura Lallos is a former Morningstar analyst and editor, and a frequent contributor to Morningstar Advisor magazine.

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