When it comes to income investing, it’s all too easy to fall into the trap of forgoing growth in pursuit of juicy dividends. It’s a major problem when investing in U.S. stocks in particular, but internationally, investors can have their cake and eat it, too: There is no reason why you cannot have both income and growth.

Buying shares for income has traditionally entailed investing in sectors that economically aren’t going anywhere.  U.S.-focused investors find themselves owning railroads, trucking companies and electric utilities, not the most exciting of sectors, and most unlikely to grow your investment as a percentage of the global economy.

Even in those so-called “tried and true” sectors, in the modern U.S. economy of huge payouts, stock options and multi-millionaire management, you aren’t likely to get the dividends you deserve. For example, the railroad company CSX Corp. (CSX) yields 1.5%, trucking company J.B. Hunt Transport Services Inc. (JBHT) yields 1.0% and even electric utility American Electric Power Co. Inc. (AEP) yields a modest 4.3%.

All three companies pay out less than half their earnings. The remainder is retained in the company, or used for share buy-backs, to provide capital gains for top management’s greedy stock options. If you can’t get decent dividends from investing in these admirable operations, dividend investing in the United States is a lost cause.

But internationally, income investment is a horse of a different color.

First, international firms don’t follow the Wall Street model of huge salaries, generous stock options and seven-figure bonuses. Less money earmarked for executive compensation means more cash in investors’ pockets.  And that’s a good thing, because international investors have a natural cynicism about retained earnings, believing that money that stays with the company is just management’s to waste. It’s much better to have the excess cash paid out in dividends, to do with, as you like.

Second, foreign markets are growing much faster than the United States. If the local economy is growing at 7% to 10%, even the railroads and electric utilities will grow at a similar pace, providing an increasing stream of profits. 

Third, you don’t need to confine yourself to companies growing at the speed of an arthritic snail to get good dividends or sacrifice the capital gains that come from investing in sectors that provide the world’s new ideas, intellectual growth and economic advance. Unlike the technology firms in the United States, some international companies in growth sectors don’t feel they have a God-given right to keep ALL the earnings under management’s control. Instead, they pay out dividends to shareholders.

The international appeal of dividends makes more sense when you remember that many of these companies are still controlled by the founders or their immediate heirs. Large dividends on their holdings are understandably attractive to these rich founding families.

Furthermore, in some countries such as Taiwan, the tax system rewards paying dividends, by imposing an additional “retained profits tax” on companies that keep too much of their earnings without making good use of them.  (The United States had a similar tax from 1936 to 1958, but the management lobby proved stronger than the investor lobby, so it was repealed.)

Internationally, you can find what seems impossible in the United States: Companies in growth sectors, with good track records, that nevertheless pay out good dividends, at least at the 4-5% level and sometimes more. By investing in such companies, investors can have the best of both worlds:

• A substantial dividend that they can live on.
• And the chance of capital gains in the future as the company expands.

It’s almost like U.S. investing in the halcyon days of 1949, when the Dow Jones Index had a Price-Earnings (P/E) ratio of 7% and a 6.9% yield (U.S. Treasuries yielded less than 3% at that time). And while we can’t go back in time, by investing internationally and picking carefully, we can get some of the advantages of an investor in 1949. And even possibly do as well as that investor did during the subsequent decade of Eisenhower growth and stock price rises.

Here’s how to “have it both ways,” when it comes to international income investing:

Administradora de Fondos de Pensiones Provida SA (ADR: PVD), commonly known as Provida, is the funds manager of the privatized Chilean social security funds, a business it has diversified to hold investments in fund administrators in Peru, Ecuador, Mexico and the Dominican Republic. Majority owned by the Spanish bank Banco Bilbao Vizcaya Argentaria with a P/E ratio at 9 times trailing earnings, and a dividend yield of 7.6%, this stock is especially juicy for income investors. Growth will likely come from increases in assets under management, as Chile becomes richer and some expansion of the Chilean pension fund model to other countries.

Acer (Taiwan) (London Stock Exchange: ACID) is the world’s third largest manufacturer of personal computers, with top technological innovation in Taiwan and the ability to manufacture in the cheap-labor rural China. P/E ratio 12 and a dividend yield of 5.6%, plus you get to participate in the growth of the PC industry.

Eni SPA (ADR: E) is Italy’s entry in the “Big Oil” stakes. Because of Italy’s neutral foreign policy posture, it has the advantage of being able to operate in countries like Kazakhstan, Libya and Venezuela where U.S. companies have difficulty. At a price-earnings ratio of only 6.7 with a dividend yield of 6.6%, it currently offers excellent value with chances for growth if oil prices stay high and new oil sources remain attractive.

[Editor’s Note: When it comes to global income issues, Money Morning Contributing Editor Martin Hutchinson knows his stuff.  An investment banker with more than 25 years’ experience, Hutchinson has worked on both Wall Street and Fleet Street and is a leading expert on the international financial markets. In February 2000, as an advisor to the Republic of Macedonia, Hutchinson figured out how to restore the life savings of 800,000 Macedonians, who had been stripped of nearly $1 billion by the breakup of Yugoslavia - and then the Kosovo War. Hutchinson’s “Insights on Income” column is a regular feature in Money Morning].

News and Related Story Links:

• Money Morning:
  Insights on Income: Foreign Markets are a Necessary Profit Play for Today’s Income Investor

• Money Morning:
  Insights on Income: Magnify Your Returns With Investments in Foreign Currencies

In a recent column, I suggested that investors seeking income (which means most of us aged 55 or older) could do better in foreign stocks than in domestic shares, especially since options-obsessed corporate managers have slashed U.S. dividend payouts in order to protect their yearly bonuses.

In this column we’re going to explore income alternatives available from short-term investments in foreign currencies, a strategy that capitalizes on both the general sogginess of the dollar and the higher yields available from some markets abroad.

Investments in short-term foreign-currency assets can potentially offer much better returns than U.S. investments for income investors, for the following reasons:

• The United States continues to run a $700 billion payments deficit annually. While that continues, the dollar will tend to be weak against other currencies. Sometimes, even low-risk investments in the right foreign currency can provide substantial capital gains – and it’s not always the obvious currencies. Did you know you could have made over 30% in dollars over the past year from a bank deposit in Czech crowns? And that wasn’t some wild-eyed risk; the Czech Republic is a perfectly solid middle-income democratic EU member with an admirable free-market president, Vaclav Klaus.

• Because U.S. interest rates are so low, many countries have higher interest rates right now, but without the escalating rates of inflation that currently appear to be afflicting the U.S. economy. Australian, Brazilian and New Zealand bank deposits all pay more than 5%. All three currencies have recently been strong against the dollar, and that’s likely to continue, even as the inflation rates in these countries remains comparable to, or lower than, that of the United States.

Foreign currency short-term assets are ideal for that portion of an investment portfolio that seeks to avoid exposure to both the risks of equity markets, and to the risks of global inflation. For the income investor who is seeking to live off some of the returns on his investments, a portfolio with too much investment in stocks – domestic or international – is vulnerable to a general global downturn, when worldwide stocks may decline in price and force investors to sell at the bottom of a bear market. International investments in bonds suffer if inflation rises, because bond yields are forced higher, causing capital losses on bond investments.

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But international investments in short-term instruments do not suffer either penalty. They are safe from stock market downturns. They are also safe from inflation, since short-term investments are continually reinvested, and in an inflationary period the new investments will generally offer higher yields, offsetting the inflationary erosion in purchasing power.

As an illustration, remember that when U.S. inflation hit 10% in 1980, short-term-investment yields rose as high as 17%, providing investors with an ample return to cover inflation’s cost.

Investment in international short-term instruments or deposits is not the same as buying a money market fund; their dollar value will fluctuate as the dollar fluctuates in value against other currencies. Needless to say, in a period such as the present (when the dollar is generally weak), the strategy that I’m detailing here can provide additional capital gains for the dollar-based investor.

There are two ways easily available to U.S. investors to invest in foreign currency short-term assets:

• One is to invest in foreign currency deposits. These are available through Everbank, with which Money Morning has a relationship. Because Everbank is a U.S. bank, its foreign-currency deposits benefit from a guarantee by the Federal Deposit Insurance Corp. of up to $100,000. Everbank offers deposits of 3-, 6-, 9- and 12-months’ maturity in a number of foreign currencies, with a minimum investment of $10,000. For example, Everbank currently offers deposit yields of 5.5% in Australian dollars, 6.13% in New Zealand dollars, 4.25% in Norwegian krone and 8.75% in South African rand, compared with deposit rates of around 3% to 4% available in the domestic U.S. market. All those currencies appear to have good prospects to rise against the dollar over the next 6-month period, except the South African rand where local inflation is above 10%.

Everbank also offers a range of multi-currency-index CDs, which provide currency diversification as well as an attractive yield. For example, its commodity index CD – containing equal amounts of Australian dollars, Canadian dollars, New Zealand dollars, and South African rand, with a yield of 5.5% – might be expected to appreciate against the dollar in periods such as the present when commodity prices are rising and commodity-based economies are doing well.

The main disadvantage of the Everbank system is that your money is physically converted into foreign currencies, incurring a foreign exchange cost of up to 1% in the process. For short-term deposits, this obviously can be expensive.

• The other possibility is to invest in one of the funds that have recently opened that specialize in investments in short-term foreign currency assets.  These funds have the advantage of being quoted in dollars, so there is no foreign-exchange cost in purchasing them. Three of these in particular appear attractive:

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  • The Franklin Templeton Hard Currency Fund (ICPHX), part of the well-known Franklin Templeton group, rated as a five-star fund by Morningstar, has a minimum investment of $1,000, but the disadvantage of a 2.25% front-end “load.” That load, or fee, is important when considering an investment in short-term assets. There is also the “advisor-class fund” (ICHHX), with identical holdings and a minimum investment of $50,000. This has no front-end load, but it appears you have to buy it through a broker, incurring additional costs. The two funds have combined assets of $693 million and were established in 1989. ICHHX has an average annual return of 7.76% over 3 years, and a yield on a trailing-12-month basis of 7.75%. The funds invest primarily in hard currency (low inflation) deposits and short-term bonds, with an average maturity of 0.16 years (2 months) – they may invest 20% of their funds in other assets, such as gold and inflationary currencies.

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  • Specialist currency fund manager, Merk Investments LLC, offers the other two funds. The Merk Hard Currency Fund (MERKX), founded in 2005, also is given a five-star rating by Morningstar, and has $435 million of assets invested in hard currency short-term bills offered by governments and prime corporations, as well as modest holdings of gold. It is up 11.62% over 3 years and offers a yield of 6.79% on a trailing 12-month basis. It has no sales load and a minimum investment of $2,500.

•  
  • The Merk Asian Currency Fund (MEAFX), was established only in April 2008, too recently to have obtained a Morningstar rating or reliable performance data, and has assets of only $45 million. Its attraction is that it specializes in short-term instruments in Asian currencies; at present, for example, it has 41% of its fund in short-term Chinese Renminbi (yuan). Again, the fund has a minimum initial investment of $2,500 and no sales load.

[Editor's Note: When it comes to global income issues, Money Morning Contributing Editor Martin Hutchinson knows his stuff.  An investment banker with more than 25 years' experience, Hutchinson has worked on both Wall Street and Fleet Street and is a leading expert on the international financial markets. In February 2000, as an advisor to the Republic of Macedonia, Hutchinson figured out how to restore the life savings of 800,000 Macedonians, who had been stripped of nearly $1 billion by the breakup of Yugoslavia - and then the Kosovo War. Hutchinson's "Insights on Income" column will now be a regular feature in Money Morning].

News and Related Story Links:

• Money Morning:
  Insights on Income: Foreign Markets are a Necessary Profit Play for Today’s Income Investor

• Wikipedia:
  Czech Republic.
• Wikipedia:
  Václav Klaus.
• Wikipedia:
  Mutual Fund Loads and Fees.

If you were an income investor, to balance those high yields, you also had to have capital appreciation, so about half your portfolio would be invested in U.S. common stocks – which, thanks to their dividend payouts, yielded a good 3%-4% themselves. Even after you paid Uncle Sam, a portfolio such as this one would have easily thrown off 5% of its value in income, and allowed you to keep up with inflation as stock prices generally rose.

Clearly, those were the halcyon days for income investing.

More than two decades later, income investors face a much bigger challenge. U.S. stocks have posted mediocre results since 2000, while bonds and cash have provided truly lousy returns after inflation and taxes are taken into account. Stocks pay lower dividends than they used to, especially since top corporate executives now are loaded up with stock options, and those decline in value every time a dividend payout extracts a big slug of cash from the corporate coffers.

The bottom line: While stock prices, interest rates, and inflation are at current levels, and U.S. economic growth remains sluggish, income investors who focus only on domestic income investments will be lucky to break even in cash terms after they have attempted to live on 5% of their capital.

There is a solution, however. In fact, this particular income strategy can offer much better returns than anything a domestic income investor can ever hope to find. We’re talking, of course, about investing internationally. Most investors think of the international markets only as another place to seek out stocks. But overseas financial markets are a great option for income investing, as well. And here’s why.

The Overseas Option for Income Investors

• The United States continues to run an annual balance-of-payments deficit of $700 billion. As long as that persists, the dollar will tend to be weak against other currencies. Sometimes, even low-risk investments in the right foreign currency can provide substantial capital gains – and it’s not always the obvious currencies. Did you know you could have made more than 30% in dollar terms during the past year from a bank deposit in Czech crowns? And that wasn’t some wild investing gambit: These days, the Czech Republic is a perfectly solid middle-income democratic European Union member with an admirable free-market president, Vaclav Klaus.

• Because U.S. interest rates are so low, many countries have higher interest rates – with lower rates of inflation. Australian, Brazilian, and New Zealand bank deposits all pay more than 5%. All three currencies have recently been strong against the dollar and will likely continue to perform so. And all three of those economies have inflation rates that are comparable to, or lower than, the United States’ rate of inflation (South Africa also has 8% deposit rates, but there inflation is too high for safety).

• While the U.S. economy scuffles along at a 1% pace – and even if it were to recover to 3% – there are a number of countries with growth rates of 5% or greater, not all of which have overvalued stock markets. China and India famously have growth rates of 9%-10%, but what about South Korea and Taiwan?  Both are richer countries with growth rates consistently in the 5%-6% range. By definition, if stocks in those countries are no more expensive than in the United States, they are likely to offer better value.

• Many stocks outside the United States pay generous dividends, often because they are still controlled by the original founding families who want the income, or because these firms are based in companies with are located in countries with good-value stock markets.

International Income Investing: The Secrets of Success

For income investors seeking dividends from international investments, the secret is to find companies with high dividend yields, but which aren’t operating in the kind of risky or highly cyclical business sectors that will make those dividends vulnerable.

In other words, what you don’t want to see is a situation where you buy into a stock for its hefty dividend yield – only to have the board of directors of that company suddenly decide that it needs to conserve cash. For instance, Telecomunicacoes de Sao Paulo SA (ADR: TSP), the fixed-line telephone system in Sao Paulo, Brazil, has a dividend yield of no less than 14%. However the company’s profit margins are under attack by the aggressive cellphone operators in the country and its earnings seem likely to decline. Indeed, the consensus forecast for TSP’s 2008 earnings is about 30% less than the dividend payout, suggesting that dividends will be forced downward – unless the company starts liquidating itself.

Some current recommendations that have good dividend payouts that are also securely covered by earnings:

• Kookmin Bank (ADR: KB): The largest bank in South Korea, Kookmin has a dividend yield of 4.6% and a Price/Earnings (P/E) ratio of less than 8.0. Kookmin has avoided an entanglement in the U.S. subprime-mortgage mess, but has nevertheless been dragged down by investor disillusionment with the financial services sector.

• Acer Inc.: Based in Taiwan, Acer is now the world’s third-largest manufacturer of PCs, with a global market share that reached 10% since its 2007 purchase of Gateway. Although there are several ways to invest in this company, this is best bought through its Global Depositary Receipts, which are listed on the London stock exchange (ACID). Acer has a dividend yield of 6.4% and a P/E ratio of only 11.0 – pretty alluring numbers for a leader in a major growth sector.
• Tele Norte Leste Participacoes SA (ADR: TNE): Also known as TNE, Brazil’s cellphone compay has a yield of 4.8% and is trading at about seven times earnings.

One final note: Income investing is all too often viewed as a stodgy, no-growth strategy for the total risk-averse. But as Acer and TNE demonstrate, you don’t need to confine yourself to stodgy, low-growth sectors to get a juicy dividend yield with good security. You just have to look globally.

[Editor's Note: When it comes to global income issues, Money Morning Contributing Editor Martin Hutchinson knows his stuff.  An investment banker with more than 25 years' experience, Hutchinson has worked on both Wall Street and Fleet Street and is a leading expert on the international financial markets. In February 2000, as an advisor to the Republic of Macedonia, Hutchinson figured out how to restore the life savings of 800,000 Macedonians, who had been stripped of nearly $1 billion by the breakup of Yugoslavia - and then the Kosovo War. Hutchinson's "Insights on Income" column will now be a regular feature in Money Morning].