International Investments for Income - Dividends From China

International Investments for Income

by jhl, Smart Investments for Income

For most American income investors, the equity income portion of their portfolio consists almost
entirely of shares of U.S.-based large cap dividend payers. There are good reasons for this. The low-risk
consistency and reliability that income investors crave are most often found in such investments.
Contrast this with a typical equity growth portfolio. Most financial advisors would recommend investing
a significant percentage of a growth portfolio in international equities. I’ve seen recommendations for
an international equity allocation as high as 30%, and even 40%.
International Diversification
One reason that dividend investors tend to avoid holding international stocks in their portfolios is that
they believe the U.S.-based multinationals in which they are invested already provide adequate
exposure for international diversification through the revenue streams those companies derive
overseas. Although it is true that they are getting some international exposure, what one has to keep in
mind is that not all international exposure is equally desirable. In fact, in the current economic
environment, some types of international exposure will likely prove detrimental to corporate earnings
and may put pressure on dividends. Specifically, income derived from countries whose currencies are
weakening with respect to the U.S. dollar can reduce the bottom line of a company significantly.
Currency Outlook and Risk
From analyses that I have read, many forecasters are anticipating interest rates in the U.S. to eventually
start moving up over the next year. This is expected to lead to the value of the U.S. dollar rising against
the currencies of other countries whose economies continue to struggle, particularly against the Euro,
Pound, and Yen. As commodity prices are expected to remain under pressure, the currencies of
countries whose economies are highly dependent on oil and other commodities are also expected to
weaken against the U.S. dollar. These include currencies from such countries as Canada, Norway, and
Australia.
Companies that have significant overseas revenues coming from these countries can be expected to
take a hit to their bottom lines starting next year. Conversely, companies with income from countries
whose currencies are expected to increase in value against the U.S. dollar will benefit from the tailwind
provided by the currency exchange and will be in a stronger position to maintain and increase dividends.
So what countries are expected to have currencies that outpace the U.S. dollar? After reading what
various forecasters are saying, I have concluded that the countries to have currencies that will most
likely do well against the U.S. dollar are China and Mexico.
International Dividend Opportunities
China and Mexico have low-cost labor and large manufacturing bases that will continue to make them
attractive production centers. Capital inflows can be expected to boost the GDP of these countries in


the coming year and lead to yuan and peso appreciation against the dollar. To exploit this possible
opportunity, I searched for good equity investments from these two countries that would pay decent
dividends. Although I found several excellent potential Mexico-based investments, none of them paid a
dividend that I consider to be high enough to qualify them as good income investments. China,
however, presented a different story.
One income-oriented equity investment that I find particularly attractive is a WisdomTree ETF – the
China Dividend Ex-Financials Fund (CHXF). With a distribution yield of about 2.23% (down from over 5%
a year ago due to price appreciation) and an expense ratio of 0.63%, this fund has exhibited the
characteristics of a good equity income investment. CHXF’s price has generally moved in sympathy with
larger index-based ETFs, like FXI, but with less volatility. It has outperformed FXI year-to-date. The fund
also avoids holding shares of the shady Chinese banking stocks that I believe are too heavily
overweighted in other ETFs.
Let me leave you with a couple of thoughts to consider:
- In emerging markets, corruption and weak corporate governance are part of the investing
landscape. Many publicly traded corporations are majority-owned by wealthy families who may
or may not have the best interests of other investors in mind. What these families almost
always want to do, however, is extract money from the corporate entities that they own. In
many cases, their preferred way of doing this is through dividend payments. In China, there is a
special case of this wherein the “wealthy family” is in fact the government (in the case of state-
run enterprises) and its communist overlords. They too extract income through dividends. And
when they want more income, they raise the dividends. That is why some investors actually
consider some Chinese dividend payers to be good dividend growth picks. I wouldn’t go that
far, but suffice it to say that if the central government has a stake in the well-being of some of
your investments (as they do in many of the CHXF holdings), then the dividend payouts from
those investments will have a certain degree of protection not available elsewhere.

- As attractive as opportunities like this may look, disciplined allocation is still a must when
investing internationally. I personally would never concentrate more than 10% of my equity
income portfolio in any one country outside the U.S., and that includes China.
So don’t shy away from looking at international equity opportunities, just be sure to do your homework.