Seeking yield: the long-term Asian dividend story

Despite the prospect of an impending Federal Reserve rate hike, we believe the long-term case for investing in Asian dividend stocks remains strong.

4 August 2015

Richard Sennitt

Richard Sennitt

Fund Manager, Pacific Equities and Global Small Cap Equities

  • Asian stocks offer an attractive long-term dividend option
  • Asian dividend yields at around pre-financial crisis averages
  • Rate risk to yield in defensive sectors
  • Selective consumer discretionary, telecoms, energy companies preferred

The unknown Asian dividend story

In the current investment climate many investors are expecting an interest rate rise announcement from the US Federal Reserve (Fed) possibly as early as September, which many believe will hurt the appeal of dividend-paying stocks.

However, this assumption ignores the positive longer-term dividend story in another part of the world: Asia. The long-term investment case for Asia is well-documented:

  • Favourable demographics
  • Rising levels of urbanisation
  • Increasing investment in infrastructure
  • A burgeoning consumerist middle class

All of which are contributing to the region’s strong long-term economic growth. While the story behind continued capital growth from Asian stocks is well-known, the dividend story is perhaps less so.

Income attraction

Despite the potential US rate rise, we believe the long-term case for investing in Asian dividend stocks remains strong.

First, dividend returns in Asia are highly-correlated to economic growth and account for over three-fifths of long-run equity returns (with capital appreciation making up the remainder).

For an active manager, the case for income in Asia is also supported by how the region compares favourably in its share of higher yielding (+4%) stocks in relation to its global market capitalisation weighting (see below).

Corporate governance and the levels of payout ratios in Asian countries also yields a positive correlation; companies with strong governance (in places such as Hong Kong and Singapore) look to create long-term shareholder value, while companies in countries such as Korea – where family-owned “chaebols” dominate – have lagged in this respect, with much lower payouts.

Furthermore, despite the compression we have seen on yields in the bond and money markets, dividend yields on equities remain at around their 10 year pre-financial crisis averages in spite of their potential for dividend growth.

Rate Risk

Although markets are focused on the potential rate rise from the Fed, the crucial factor to watch will be how fast rates rise from there.

In this respect, we think rates will rise gradually and this should make the transition to a normalisation of rates more manageable for income-yielding stocks.

Having said that, we do see some stocks in the more defensive sectors, such as consumer staples, utilities and healthcare, being more at risk from a rising rate environment given many appear relatively fully-valued versus the rest of the market.

Asian context

Although Asian stockmarkets have lagged global markets’ returns, this underperformance has come despite Asian companies having a broadly similar earnings profile to their global peers.

While valuations in other markets have seen a rerating upwards, Asian markets have not.

The China story

In part, sentiment remains relatively negative owing to the slowdown being seen in China.

Here, for producers, deflationary forces remain entrenched and are exacerbated by the elevated level of the currency.

Domestic corporate earnings remain under pressure and we are sceptical whether financial engineering will feed through to sustainable growth.

Governments and policymakers are in a better position to deal with any fluctuations in exchange rates.

Furthermore, structural issues such as debt and blatant overcapacity in the system continue to hinder growth.

This backdrop, unsurprisingly, has led us to avoid large parts of the market including a number of the financials there, in particular the banks.

We prefer selective consumer discretionary, telecoms and energy names.

Falling commodity prices

The current global situation – where oil is hovering around $50 a barrel – also favours much of Asia, which is a large net oil importer.

This is particularly beneficial to countries such as India and Indonesia, where inefficient fuel subsidies previously led to large current account deficits.

Falling commodity prices should benefit the region both from a macro perspective and a micro one with falling input costs for companies and improved spending power for the consumer.

Thus far there has been relatively little evidence of an improvement in domestic economic conditions as monetary conditions have remained relatively tight as economies brace themselves for September’s possible rate hike.

However, in contrast to the ‘taper tantrum’ of 2013, though, the region’s economies are in better shape to weather the volatility given the general improvement in their external accounts.

In Asia, the overall long term picture for investing in the region remains as strong as ever.

Current account deficits have fallen in countries such as India and Indonesia and most of the debt held by companies are denominated in local currencies; a far cry from the days of the 1997 Asian Financial Crisis when Asian companies’ succumbed to the weight of US-denominated debt that built up on balance sheets following sharp falls in their currencies at a time when many countries ran substantial current account deficits.

This time, governments and policymakers are in a better position to deal with any fluctuations in exchange rates and spending and to an extent expectations of a rate hike are more widespread now than then were in 2013 when talk of ‘tapering’ shocked the market.

On the global front export demand from Asia has been subdued versus previous cycles but any pick-up in growth globally will support earnings for Asian companies as the region remains the world’s factory.

In aggregate, valuations of Asian markets continue to trail those of the rest of the world reflecting the low expectations for growth in the region versus elsewhere.

Long-term income

Ultimately, investors must remember that companies that create real shareholder value will normally have a supportive shareholder returns policy, often manifesting itself via a favourable dividend policy.

In Asia, the overall long term picture for investing in the region remains as strong as ever.

And in a world where interest rates are still low, and with inflation rates on the cusp of deflation in many of the world’s developed economies, investing in dividend stocks offers investors both a relatively attractive income stream and potential for long-term capital appreciation.

As always, we maintain a disciplined bottom-up investment view and continue to look for good companies where we see a strong income case and potential for capital growth.

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