Going for global income Going for global income http://www.federatedinvestors.com/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\article\globe-hands-sustainable-small.jpg February 24 2020 February 19 2020

Going for global income

Jared Hoff explains why investors may benefit by expanding their dividend horizons.
Published February 19 2020
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Q: Why consider a global approach for dividend income?

International markets generally are much more fertile for dividends than here in the U.S., where the S&P 500 is yielding just 1.8%. Meanwhile, in mature markets outside the U.S.—the U.K., Canada, the eurozone, Switzerland, the Nordic countries, etc.—you can find much higher yields, currently around 3% to 5% on average. That gives us a broader universe of attractive dividend stocks to consider.

Part of this phenomenon is simply cultural. Especially in developed Europe and Canada, shareholders have a long history of requiring a cash return, the result of company boards considering the demands of their shareholders. These companies are more apt to treat their shareholders like business owners. They incentivize them to continue to own their shares by paying them a portion of the company’s profits.

And shareholder demands for cash returns have gotten louder since the advent of exceptionally low bond yields.

Q: What about dividend opportunities in emerging countries?

Currently, emerging markets (EM) don’t offer much opportunity to collect high and sustainable dividend streams. Many EM companies are in rapid growth mode, and they need to reinject profits back into the business to fuel expansion. This can be good for growth, but bad for dividends.

There also are structural issues in the EM that limit dividend opportunities. The economies of EM countries are generally more reliant on cyclical industries, which can raise the year-to-year earnings variability of businesses that are domiciled there. EM companies also are more likely to do business only in their home countries or regions. All of these factors can drive higher earnings volatility that raises the risk of dividend cuts for companies that have high payout ratios.

Given our goal to reduce risk and volatility for our clients, investing directly in EM companies is generally not a natural fit for our strategy. But across our portfolios we do have indirect exposure to the EM—we consider it part and parcel with taking a global approach to dividend investing. Whether investing in the U.S. or abroad, we have a preference for companies that generate sales from all over the world. We like the diversification that global companies can provide, and the diverse sources of cash flows they can tap into. Global companies can benefit from the exceptional growth rates in the EM and, at the same time, enjoy the cash flow durability of stable developed markets.

Q: Are there sectors overseas where dividend payouts are typically higher than in the U.S.?

On the whole, most sectors outside the U.S. offer higher payout ratios. But it’s just as much the balance of sector exposure outside the U.S. that contributes to higher average payout ratios.

For example, in the U.S., we have a massive Technology sector. Tech makes up nearly one fourth of the S&P 500 and this sector concentration has a lot to do with why the dividend yield and the average payout ratio for the index is so low. Many tech companies are in secular growth modes and require a constant reinjection of cash to maintain their growth trajectories.

By comparison, international markets are more heavily weighted in sectors outside of Tech, where growth rates and capital requirements are lower. So, on average, we’re seeing more foreign companies with excess cash. And those non-U.S. companies have proven more willing to return it to shareholders than many of their U.S. counterparts, which often spend the money on mergers and acquisitions and large share repurchases. As a result, growth generally will be lower in foreign developed markets, but the silver lining is a greater abundance of generous dividend policies.  

Q: What are the risks in pursuing dividends overseas?

Because dividend payout ratios are higher outside the U.S., we need to be extra vigilant in order to identify companies whose dividends are sustainable through the business cycle. In other words, can the dividends stand up to a temporary decline in earnings?

To address the risk of earnings variability in a high-payout investment universe, it’s important to favor companies with healthy balance sheets that generate relatively steady free cash flow throughout the business cycle. So we maintain a defensive bias and specifically look for companies that can generate relatively durable profits even in periods of economic weakness. Many of those types of companies can be found in such non-cyclical sectors as Communications Services, Consumer Staples, Health Care and regulated Utilities.

We believe that taking a non-cyclical approach to dividend investing is a prudent line of attack, both inside and outside the U.S. But it’s especially appropriate to emphasize “defense” when investing in mature markets outside the U.S., where economic growth has been slower and the threat of recession has been more frequent.

Q: Are fluctuating currencies a concern?

While there are richer sources of dividends outside the U.S., we have to be aware of the impact of currency. International companies typically declare their dividends in foreign currencies. For U.S. shareholders, those dividends get converted to U.S. dollars, so the foreign exchange rate can have a noticeable impact on the dividend that we ultimately collect. So when investing for income outside the U.S., it’s essential to plan for greater variability in the dividend stream that’s caused by currency fluctuations.

For most of the last decade, the strong dollar has been a headwind to dividend growth for U.S. investors in foreign companies. On the other hand, when the dollar weakens, U.S. investors enjoy an accelerated dividend growth rate when their foreign dividends are converted to dollars.  

Tags Equity . International/Global . Active Management .

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

Dividend payout ratio represents the percentage of earnings paid to shareholders in dividends.

International investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards. Prices of emerging-market and frontier-market securities can be significantly more volatile than the prices of securities in developed countries, and currency risk and political risks are accentuated in emerging markets.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

Stocks are subject to risks and fluctuate in value.

There are no guarantees that dividend-paying stocks will continue to pay dividends. In addition, dividend-paying stocks may not experience the same capital appreciation potential as non-dividend-paying stocks.

Federated Equity Management Company of Pennsylvania