Dividend Investing Abroad

Whether to increase income as interest rates scrape bottom, or to reduce equity risk in a volatile market, investors in the United States have been in hot pursuit of dividend-paying stocks. Funds such as  Vanguard Dividend Growth (VDIGX),
 Federated Strategic Value Dividend (SVAAX), and
 Franklin Rising Dividends (FRDPX) have seen their asset bases burgeon during the past year, even as U.S. equity funds overall have lost $72 billion for the year through October.

Yet even as domestic dividend-oriented funds have gained in popularity, attractive yield-rich opportunities might be just as plentiful--if not more so--abroad.

In a Morningstar interview earlier this year, 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  ExxonMobil (XOM)," Woort-Menker noted. Both global integrated oil-and-gas companies are reliable dividend stalwarts, but Morningstar currently calculates a projected yield of 4.5% for Royal Dutch Shell, as opposed to 2.5% for U.S.-based ExxonMobil.

That's not an isolated example. Even the bluest chips have been embroiled in the European crisis, and while share prices have rebounded during the past year, foreign funds' yields are, in many cases, more attractive than their U.S. counterparts. Indeed, the median foreign large-cap value fund has a 12-month-yield of 2.65% as of Nov. 30 compared with 1.43% for the median U.S. large-value fund.

Now might 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 article. 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, due 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. Also note that the tax on all dividends--both qualified and nonqualified--is set to increase to the ordinary income tax rate in 2013, barring Congressional action. 

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 6.6% 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. Although they might use dividend yields as an initial hurdle, their bottom-up analysis and quality controls can keep them out of yield-rich but otherwise troubled companies. The funds below are all centered on sensible dividend strategies. They might not boast yields as steep as those of their bolder deep-value peers, but they are likely to be easier on the nerves. 

 Allianz NFJ International Value (ANJIX) 
Domestically focused  Allianz NFJ Dividend Value (PNEAX) is much larger, but its foreign large-value sibling also deserves a mention. Ben Fischer leads the management team of both funds, focusing on dividend-paying stocks trading at a discount to book value. Although this fund lost a bit more than its peers in 2008, it has not been unduly risky. And long term or short, its returns are among the best in the category. 

 American Funds International Growth & Income (IGAAX) 
Although this foreign large-blend fund opened less than four years ago, its managers have long and successful track records at other American Funds. This one demonstrated the benefits of its dividend focus when it lost less than 96% of its peers in 2011. It might not keep pace in rallies, but this has shaped up to be the sort of steady performer investors expect from American Funds. 

 Tweedy, Browne Worldwide High Dividend Yield Value (TBHDX) 
Name aside, this world-stock fund is not designed to maximize dividends, and its trailing 12-month yield is less than 2%. However, its portfolio of high-quality, dividend-paying blue chips has done what it is intended to do: hold up beautifully in down markets. In fact, it managed a 4% gain in 2011, while its average peer lost nearly 8%. 

 Matthews Asia Dividend (MAPIX) 
This fund, with a trailing 12-month yield of 2.5%, focuses on companies with growing dividends and has been one of the lowest-risk ways to invest in the diversified Asia-Pacific category. In fact, its three-year standard deviation of 13 would be moderate for any foreign fund. (The MSCI EAFE index, which focuses on developed markets, currently has a standard deviation of 19.5.) Although this specialized portfolio won't serve as a core holding, even a conservative equity-income investor might be tempted to invest a bit in this regional player.

A version of this article appeared June 11.