The search for income has grown in importance amid continued market volatility. Investing to provide a regular source of income has also increased in ageing societies with the need to support a longer retirement. A stampede into traditional safe havens, such as high quality bonds, and prevailing low interest rates globally have seen yields fall to historically low levels.
Potentially higher, although riskier, returns can be found in emerging equity markets and high yield bonds, but this type of asset class is not always suitable for risk-averse investors. This situation has awakened many investors to the income opportunities found in an equity dividend strategy.
All-weather strategy
The compounding effect of reinvested dividends over time accounts for a large component of total returns. And investing in equities for dividend income is not just a defensive strategy in bear markets – dividend investing can be a strategy for all weathers.
Adopting a dividend strategy that combines sustainable dividend yield with a growth kicker can capture robust total returns and perform well in different phases of the economic cycle. The Asia Pacific region is now an attractive dividend-paying destination for investors. Not only has the number of companies paying dividends increased, Asia ex-Japan companies have seen the second-best dividend per share (DPS) growth among major market gauges during the last decade (second only to a broader MSCI Emerging Markets measure).
Income and capital appreciation are not mutually exclusive. A dividend-investing strategy can enhance long-term total returns by looking beyond current dividend yield and including stocks with the potential to grow dividends and offer an element of capital growth.
This is particularly relevant to Asia, where companies with dominant positions or market leadership potential in fast-growing sectors, such as the internet and smart phones, can offer both capital appreciation and robust payouts side by side. In uncertain macro and market conditions, investors tend to favour companies with stable earnings and a proven ability to produce good results regardless of the ups and downs of the economic cycle. Asia is currently home to many such companies.
Asia’s changing landscape
A global dividend strategy that maximises the set of investment opportunities and avoids concentration risks, may be the preferred option for many investors. However, Asian markets currently sit within a dividend sweet spot as corporate cash flows are growing together with falling capital expenditure and gearing levels.
Since the 1997/8 Asian financial crisis, many Asian companies have matured and learned some hard lessons about high levels of leverage and overexposure to exchange rate risk. Prior to the Asian crisis, there tended to be little emphasis on dividends in the region, particularly in Southeast Asia, where reinvesting earnings to drive growth was preferable to rewarding shareholders with regular payouts.
That has changed, and within the Asia Pacific region. Dividends account for more than 50 per cent of total returns from the MSCI Asia Pacific ex-Japan Index over the past 15 years. Adding an Asian dividend perspective to your portfolio can therefore be appealing in its own right; it can be an attractive diversification option or simply preferable for Asian investors who prefer to stay close to home.
Almost 90 per cent of Asia Pacific ex-Japan companies paid dividends in 2011 compared to about 60 per cent in 1998. Since the financial crisis shakeout, many Asian companies have deleveraged, increased cash reserves, and lowered their net debt to equity ratios, particularly in ASEAN countries such as Thailand and Indonesia.
As previously high-growth Asian companies have matured, they have developed a stronger appreciation of shareholder value, including improved corporate governance standards and sustainable dividend policies. Today’s expanded Asian dividend stock universe offers plenty of high yielding investment opportunities across a wide range of sectors.
Valuations still appeal
Asian dividend stocks enjoyed a respectable rally in 2012 as investors gravitated to defensive counters amid ongoing market volatility. This has led some to question whether these stocks have become too expensive and a crowded trade. But according to an in-depth survey by analysts at CLSA, only the well known pockets of the high yield universe can be described as being expensive on a relative and historical basis, while the wider universe still offers sustainable yields at attractive valuations.
Top quintile Asia Pacific high-dividend stocks are trading at around 1.7 times price-to-book value versus 1.9 times for high-yielding US stocks and 1.7 times for top quintile Europe high dividend stocks, but dividend yield in Asia on average, is higher than in many global markets.
It’s a fact that the Asia Pacific dividend stock universe is skewed towards financials, and this raises the spectre of concentration risk. This has not been a concern since the 2008/9 financial crisis because Asian financial stocks, and particularly banks, now have relatively stronger fundamentals compared to their US and European counterparts, which are still undergoing a deleveraging process.
Australian banks in particular have established a reputation for paying robust dividends coupled with relatively high levels of corporate governance for the region. Select China banks have also become an equity dividend target supported by earnings growth and resilient net interest margins.
Technology is also weighted heavily in the Asia Pacific dividend pool, and Taiwan – which has many market-leading semiconductor and smart phone components manufacturers – is a significant source of high-yielding stocks. As demand for smart phones, tablets and touch panels increases globally, Taiwanese component firms have continued to expand their position in the global supply chain.
The dividend yield of Taiwanese technology stocks currently stands at around 3.3 per cent and this is expected to be sustained given the positive growth prospects. More broadly, an increasingly affluent middle class within Asia is driving an increase in discretionary consumption, and companies in these sectors, such as handset-camera makers and textile manufacturers, are increasing their profits and dividends. Meanwhile, traditional defensive plays, such as telecoms stocks, remain a reliable source of dividend income.
Research is paramount
While the attractions of equity income investing are obvious in a low interest rate environment, stock selection is crucial at all times. Above all, investors need to identify companies that distribute sustainable dividends. A good dividend strategy is one that extends beyond a simple focus on obtaining the highest current dividend yield. This kind of passive approach would fail to detect an artificial boost in yield due to share price deterioration. Similarly, this kind of approach can lead to an undue overweighting or concentration risk in certain high-paying countries and sectors. Identifying companies with a sustainable dividend policy or those that are expected to increase their dividends over time is a better philosophy.
In Asia, stocks can be found that offer both strong dividend and capital growth potential due to secular trends such as a growing middle class, increased wealth and private consumption, and planned infrastructure spending across the region. Asia is home to many companies that are either current market leaders or can obtain that spot over the coming decade.
Ultimately, we believe that while a dividend income strategy can cushion investors in times of market volatility, a company’s dividend policy is a broader indicator of its overall quality. A carefully constructed dividend strategy, that combines dividend sustainability with an eye on future growth capabilities in the fast-growing Asia Pacific region should be able to deliver attractive returns over the long term.
Gareth Nicholson is an investment commentator at Fidelity Worldwide Investment
