Wednesday, August 30, 2017

International Securities For A Diversified Income Portfolio

Most investors that understand the merits of asset allocation also understand the importance of including an international allocation in their portfolio. The concept is that in "normal" times there is always a market somewhere in the world rallying. To meet my international allocation, I have focused on the following areas within my portfolio:

I. International Fund in my 401(k)

My 401(k) offers an international equity fund. The Fund seeks an investment return that approximates as closely as practicable, before expenses, the performance of the MSCI EAFE Index. The Fund will typically attempt to invest in the securities comprising the Index in the same proportions as they are represented in the Index.

II. International Exchange Traded Funds (ETF)

There are several ETFs with a large international exposure. Some of these are held in my High-Yield portfolio, where a higher than average level of volatility is expected. Below are several funds with international exposure:

- WisdomTree Emerging Markets Income (DEM) | 96% International | Yield: 3.4%
- EV Tax Adv Global Dividend Inc (ETG) | 45% International | Yield: 7.4%
- Brookfield Global Listed Infrastructure (INF) | 40% International | Yield: 7.3%

III. Individual International Dividend Stocks

It was my desire to have international representation within my income investments, so I first looked to identify good non-U.S. dividend individual stocks that had an ADR trading on a U.S. stock exchange. To identify these stocks I used the International Dividend Achievers™ list.

To become eligible for inclusion, a company must be incorporated outside of the United States. The companies must be have an American Depository Receipt or common stock trading on NYSE, NASDAQ or AMEX. Companies must have paid increasing regular annual dividends for five or more consecutive years. What I found is that most companies outside the U.S. follow a different dividend model. Here are some of the differences:

- Many foreign companies pay dividends based on a percent of earnings. This produces a very erratic cash stream.
- Many foreign companies only pay dividends annually. I need more feedback than this. I would hate to wait a full year before learning a company plans to slash its dividend.
- Most foreign companies pay dividends in their local currency. Most Canadian companies pay quarterly consistent dividends, similar to companies in the U.S. However, they pay the dividends in Canadian dollars, so the currency risk is with the U.S. investor. There is probably much less fluctuation between the U.S. and Canadian dollars than most other currencies.

IV. U.S. Based Stocks With Significant International Exposure

One way to gain international expose without any of the problems listed above, is to hold blue-chip, U.S. based corporations with large foreign operations. These multinationals pay quarterly dividends and generally assume the currency risk. Below are several large companies that derive at least 45% of their revenue outside the U.S.:

Colgate-Palmolive Company (CL) is a major consumer products company markets oral, personal and household care and pet nutrition products in more than 200 countries and territories.
68% 2016 Foreign Sales | Yield: 2.3%

McDonald's Corporation (MCD) is the largest fast-food restaurant company in the world, with about 35,000 restaurants in 119 countries.
66% 2016 Foreign Sales | Yield: 2.4%

Microsoft (MSFT) develops, licenses, markets, and supports software, services, and devices worldwide.
50% 2016 Foreign Sales | Yield: 2.1%

Johnson & Johnson (JNJ) is a leader in the pharmaceutical, medical device and consumer products industries.
47% 2016 Foreign Sales | Yield: 2.6%

In the past, I had concluded that income investing and international securities didn't mix very well for all the reasons listed above. My plan was to focus on U.S. equities for my dividend income portfolio and use my 401(k) to ensure an adequate international allocation.

Going forward, I will continue to use my 401(k) for the majority of my international allocation. However, as I find funds with international holdings that pay a stable/growing dividend, I will include them in one of my income portfolios. Also, I plan to add a few more international stocks, but will limit my holdings due to the instability of their dividends.

I am always looking for ways to improve my portfolio, without significantly increasing the risk.

Full Disclosure: Long CL, MCD, MSFT, JNJ. See a list of all my Dividend Growth Portfolio holdings here.

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