How to diversify your dividends

by , 9th May 2018

When it comes to dividend payouts, the UK has long been one of the more generous global markets – the FTSE 100 currently yields around 4% overall. That’s partly because the UK has been something of a global laggard in terms of capital gains during the recovery from the financial crisis.

It is also because the UK has more than its fair share of companies within sectors that tend to pay higher income, such as big pharma, big tobacco, and the utilities stocks; as well as cyclical sectors which can currently afford to pay decent dividends, such as the oil and mining giants.

However, while a chunky dividend income is nice to have, it can also come with risks. As UK-based investors will remember, pre-2008, some of the biggest dividends were being paid by the banking sector. Not much of that survived the crash. And even if nothing that extreme happens again in the near future, it’s never a good idea to have too much of your wealth dependent on one sector or geographic area. We all suffer from “home bias” (a tendency to invest far too much in our domestic market and not enough globally) and it can make us miss out on good opportunities elsewhere in the world. So which markets should income investors be paying particular attention to?

The first market on the list might come as a surprise. Japan has a long history of neglecting shareholders, which includes a miserly attitude towards paying out dividends. However, as many investors are now realising, corporate reforms pushed through by the Shinzo Abe government – as well as a general attitude change on the part of companies themselves – is starting to have an impact. The benchmark Nikkei 225 index yields 1.8% – that doesn’t sound much, but five years ago it was 1.4%.

As for the wider Topix index – in 2004, the payout ratio (the percentage of a company or market’s earnings that are paid out as dividends) came in at 17%. Now it’s more like 30%, which points to another key issue with dividends – you want to consider future dividend growth, as well as the absolute level of dividends when you invest. On that front, while many investors argue that the FTSE’s dividend cover is looking a little thin, Japan’s has plenty of room to grow still.

One interesting Japan ETF option is the Lyxor JPX-Nikkei 400 UCITS ETF (LSE: JPXG) which tracks the JPX-Nikkei 400 index, a selection of 400 companies deemed to be, in effect, more shareholder-friendly than the average Japanese company. The dividend yield is around 1.9%, though be aware that this ETF reinvests the dividend income rather than pay it out.

Going to the other end of the dividend table, if you look at a list of the highest-yielding markets, there are some interesting candidates in there. According to the ever-useful Star Capital website, the highest-yielding markets (based on dividend payments over the previous 12 months) currently include the Czech Republic (more than 5%), Russia (just under 5%), and Australia (around 4.5%). The top 10 also features Portugal, Spain and New Zealand.

One problem is that outside of deep and liquid markets such as the US and Japan, investing in single markets like the ones listed in the paragraph above is likely to expose you to a lot more concentration risk. For example, take the Czech Republic. The Prague Stock Exchange plays host to 12 companies, of which, two utilities and two banks provide the lion’s share of the dividend spoils. Or how about Russia? It’s a controversial market, though with some undeniable attractions. But do you really want to invest in a single-country ETF there?

A better bet would be to opt for ETFs that give you exposure to specific high-yielding regions, such as Eastern Europe or the eurozone as a whole. For Eastern Europe, you can buy the iShares MSCI Eastern Europe Capped UCITS ETF (LSE: IEER), which currently yields around 3%. Nearly two-thirds of the ETF is invested in Russia, with Poland, Hungary and the Czech Republic making up the rest. One dividend-focused option for Europe more widely is the WisdomTree Eurozone Quality Dividend Growth ETF (LSE: EGRA), which looks for dividend-paying eurozone stocks that also have “quality” and “growth” factors – in other words, they pay dividends but they should also be able to sustain and grow them, which explains the not-especially-generous 1.9% yield. For a punchier 3.2% yield, try the S&P Euro Dividend Aristocrats ETF (LSE: SPYW), which is designed to track the performance of the 40 eurozone stocks with the highest dividend yields, that have also maintained or raised their dividends for at least 10 years in a row.

Alternatively, if you’d rather not spend too much time trying to find the best individual markets or regions, then why not invest in a ready-made global dividend ETF – an ETF that picks the highest-yielding stocks from around the world. One example is the Vanguard FTSE All-World High Dividend Yield ETF (LSE: VHYL) which is designed to track the FTSE All-World ex-US High Dividend Yield Index. The biggest holding is healthcare giant Johnson & Johnson, while other top ten holdings include consumer goods group Nestle and US bank Wells Fargo. About a quarter of the ETF is invested in financial companies, while consumer defensives and healthcare combined take up another 23%. The ETF currently yields about 3.2% a year.

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