How to build an international income portfolio

When I first became interested in investing 20 years ago, it was routine for private investors to own only London-listed shares and UK-focused funds.

Today, though, more often than not you see foreign shares and funds in the mix.

This shows good progress against ‘home bias’, one of those behavioral foibles that can lay us low as investors.

Home bias is the tendency of domestic investors to own more of their own country’s stock market than that local market’s weighting on the global stage.

For example, the London Stock Exchange represents less than 10% of the global stock market capitalisation.

In theory, a globally diversified British investor should therefore have more than 90% of their money overseas!

If you’re a stock picker like me that may seem rather pie in the sky. It’s hard keeping track of London-listed companies, let alone following stocks from every other corner of the globe. I prefer to focus my research on London-listed firms.

However, like many of us nowadays, I do dial down my home bias by making use of index-tracking funds, as well as a few foreign-listed shares, particular US firms.

Cheap ETFs that enable you to invest in foreign markets with a couple of mouse clicks make this easy. The decline in costs for trading US and European shares is another reason why it’s simpler than ever to avoid home bias.

The uncertainty of British politics in recent years – and the corresponding weakness in the pound – has probably motivated more of us to look abroad for returns.Portfolios made in Britain

Home bias seems alive and well when it comes to income investing, though.

Many income portfolios held by private investors consist entirely of dividend-paying London-listed shares, chosen in large (though not exclusive) part for their high starting yields. Foreign shares rarely get a look in.

True, most big British blue chips earn much of their income overseas. Think Royal Dutch Shell or Unilever.

But such investors are still taking a risk by having all their eggs in the UK basket. They are also missing out on some great opportunities overseas.

Parochial pensioners

I see a similar theme extending into this era of pension freedoms and drawdown.

I’m a bit of a junkie for those portfolio reviews you see in the investing press and Sunday papers. And again I’ve noticed UK equity income funds tend to hold the most appeal to retirees seeking an income.

I do believe such funds have a lot to offer retirees. Particularly in their investment trust form, many UK equity income funds have strong track records of reliably paying rising dividends.

But excessive home bias is a real risk. Some markets have languished for decades for various different reasons – the worst being revolution!

While owning a foreign tracker fund probably won’t help you in the event of a Maoist coup in Westminster, it’s a good idea to spread some money overseas for more mundane diversification benefits.

Excitement abroad

The good news is dividends are alive and well around the world, meaning an income portfolio need not settle for less loot just by broadening its horizons.

The latest data from the Janus Henderson Global Dividend Index shows global dividends surged 12.9% in the second quarter of 2018, to total just shy of $500 billion.

And the global dividend payout has risen more than 80% since 2009.

Indeed, so strong is global dividend growth at the moment, the same forecaster has upgraded its expected longer-term dividend growth rate from 6% to 7.4%.

Of course, as an income investor considering moving some of your money to capture your share of this foreign cash flood, what matters to you is the yield on your invested capital, not the total payout.

The UK market has long had a generously high natural dividend yield, which is another reason why it is so attractive to income investors.

In contrast, markets like the US and Japan are traditionally tagged more as growth plays. Dividends have often seemed an afterthought.

But that view needs updating, at least with respect to some parts of the world.

It’s true most US firms have continued to prefer share buy backs to substantially lifting their dividends in recent years.

But dividends have surged in Japan, as part of a wider change in that country’s corporate culture.

Dividends have also been growing quickly in the wider Asia Pacific region, and they’ve been recovering in Europe, too.

How to diversify with international dividends

Global dividend growth makes for an encouraging tailwind, but income investors usually want to dig deeper.

You can refine your hunt for superior foreign dividend payers by choosing specialist active or passive funds – and still bag those diversification benefits.

Let’s consider a few ETFs to see what I mean.

iShares offers a cheap global market tracking with its MSCI World ETF(LSE: IWRD). This is an easy way to bolt some diversification onto your portfolio.

However, even with dividends from global companies rising, the distribution yield here of 1.6% won’t get many income investors excited.

You have to dig a little deeper. Income-orientated overseas ETF options include:

• iShares World Quality Dividend ETF(LSE: WQDV) that yields 2.3%.

• SPDR S&P US Dividend Aristocrats ETF(LSE: UDVD) with a 2.8% yield.

• SPDR S&P Euro Dividend Aristocrats ETF(LSE: EUDI) yielding 3.2%.

• iShares Asian Pacific Dividend ETF(LSE: IAPD) yielding 5.2%

You might find that not all investing platforms offer these ETFs, but there are also investment trusts whose holdings are dominated by overseas income payers, such as JP Morgan Global Growth and Income(LSE: JPGI), yielding 3.8%, and Murray International(LSE: MYI) yielding 4.5%.

Similarly, you’ll find country-specific overseas income investment trust options.

I mentioned the US market is stingy for dividends, for instance, but Aberdeen’s North American Income Trust(LSE: NAIT) achieves a yield of 2.9% by holding some of that country’s biggest income payers.

These are just ideas to get you going with your research, not recommendations. With ETFs, be sure the methodology of the index being tracked is right for your aims. With trusts, nothing beats reading a few annual reports.

The point is there’s no excuse not to think globally if you’re investing for income.

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Both Owain and The Motley Fool own shares in Unilever.

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