The search for higher yields in a low-yield world knows no bounds, certainly not geographical boundaries.
Foreign stocks generally pay higher dividends than U.S. stocks, Philip Camporeale, executive director at J.P. Morgan Asset Management, said in an interview. Part of the corporate culture in many other countries is to pay out earnings as dividends. Investors looking for dividend-paying stocks also can get more diversification by going outside the U.S.
To support his assertions, Camporeale provided data, as of the end of the first half of 2013. The MSCI All-Country World Index ex U.S. was yielding 3.1%, versus 2.1% for the S&P 500. Among major world markets, especially high dividend yields were available from Australian stocks (4.5%), followed by those in France (3.7%) and the U.K. (3.6%).
Just as important, according to Camporeale, a client portfolio manager in the firms Global Multi-Asset Group,investors going abroad for dividend payers have a much greater ability to fill their sector preferences with attractive issues. In the U.S., he said, managers focusing on dividend payers may hold a great deal of utilities and telecom stocks. Some portfolios hold as much as 40% in utilities. We dont want nearly that much exposure to that sector, which might be overvalued now.
By going international, investors can find higher yields virtually everywhere. In every single sector, except consumer staples, foreign stocks have higher dividend yields, Camporeale said. That provides much more flexibility in setting sector exposure.
Camporeale mentioned technology and energy as sectors where its especially helpful to seek foreign dividend payers. Energy stocks in the MSCI index mentioned above yield 4.0%, versus 2.1% for their competitors in the S&P 500. Within the information tech sector, foreigners top domestic dividend payers, 2.1% to 1.6%. Why buy Facebook (no yield) or ExxonMobil (yielding 2.8%) when sound foreign companies pay hundreds of basis points more in dividends?
If investing in foreign dividend payers offers higher yields and more diversification opportunities, what are the drawbacks? Investors are exposed to broader sentiment, which can turn negative, Camporeale said. If investors are concerned about Europe, prices of those stocks might fall. The same can be true of emerging markets.
Moreover, U.S. investors holding foreign dividend-paying stocks may have to face some wrinkles in the tax code. Today, U.S. investors generally get a break on dividend income, paying tax at 20%, 15%, or even 0%. However, dividends from stocks based in certain foreign countries may not qualify for these rates, so investors could owe as much as 39.6% in tax on those dividends.
In addition, some countries require companies to withhold tax on dividends paid to U.S. investors. With 10% withholding, for instance, a 4.0% dividend would actually mean a 3.6% payout to shareholders.
Investors who pay foreign tax up to $300 ($600 for married couples filing jointly) can claim a dollar-for-dollar tax credit on their U.S. tax return. For larger amounts, though, investors can claim this credit on IRS Form 1116, which can be daunting, or take a (probably less valuable) itemized tax deduction for taxes paid. If foreign dividend payers are held in an IRA or other tax-deferred retirement account, neither a tax credit nor a deduction is available as an offset. Advisors should know about the likely tax consequences of owning foreign dividend-paying stocks, and make sure clients are fully informed.