Overseas Dividend Payers: Slow to Pay Off

Most of the funds and ETFs that rushed to buy international dividend-paying stocks have suffered big losses amid the market devastation

Over the past two years at least 12 mutual funds and exchange-traded funds (ETFs) were launched to focus on investing in international dividend-paying stocks. It's an intriguing strategy since overseas dividends are, on average, higher than those in the U.S., and dividends have historically accounted for 30% of total return from global equities, according to Citi Investment Research.

But the launches could not have come at a worse time. International stocks have been decimated, and dividend cuts have spread throughout the financial sector. Lord Abbett International Dividend Fund is down 49% since its inception last June, while Wisdom Tree International Dividend Top 100 Fund (DOO), an ETF, and iShares Dow Jones EPAC Select Dividend ETF (IDV), both launched in 2007, are off 57% and 61%, respectively, for the past year. All told, the universe of international funds and ETFs with "dividend" in their names has fallen an average of 54% (through Mar. 6), vs. a 53% decline for the average international equity offering, according to Morningstar (MORN). One exception: Tweedy, Browne Worldwide High Dividend Yield Value Fund (TBHDX), which invests in the U.S. and overseas. It fell 40%, far less than its peers, and ranks in the top 9% of world stock funds, says Morningstar.

One big problem with many of these portfolios is that they were designed based on international dividend indexes at a time when financials, traditionally strong dividend payers, dominated those indexes. But even active managers of dividend-oriented portfolios have not been able to avoid the troubled financial sector. "We have not dodged all the bullets," says Lord Abbett manager Vincent McBride, noting the fund's 18% position in financials. "Yields are higher overseas, so you are being paid to wait. But dividends have been cut, and they'll continue to be cut." As the financial crisis worsened, McBride says, he has become increasingly focused on balance-sheet strength. "The yield in the portfolio has not gone down, but we have upgraded the quality of companies," he says. Among the stocks he's bought recently are Japan's Nintendo and Canon.

The key, more than ever, is picking wisely in a treacherous market. While many of the international dividend funds have performed miserably, there are good reasons to include dividend stocks in an overseas portfolio, especially in a down market. Dividend yield has consistently produced more return in developed international markets than in the U.S., according to Empirical Research Partners. Some 90% of international companies offer dividends, vs. roughly half of U.S. companies, and their yields are typically higher. The dividend yield of companies in the MSCI EAFE index (which tracks stocks in developed countries in Europe, Australasia, and the Far East) averages 5.8%, vs. 3.3% for the Standard & Poor's 500-stock index, and fund managers say they are finding strong global franchises yielding 6%.

Simply targeting the highest yields is a recipe for disaster. The companies that pay them are often stretched financially and are the most likely to cut dividends. The value managers at Tweedy Browne look for companies that are trading at discounts to intrinsic value (what a private buyer would pay for all of the company's parts) and that have above-average dividends and a long history of paying dividends, says Managing Director Robert Wyckoff Jr. Top holdings include Unilever, headquartered in London and Rotterdam, which yields 6%, and Britain's GlaxoSmithKline (GSK), with a yield of 6.6%. Says Wyckoff: "Everything is down now, but I don't think the defensive nature of dividend investing has been tainted by this crisis."

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