Head of Asian Equities
Asian markets are often perceived as being driven mainly by growth considerations. However, as investors wrestle with the distorting impacts of quantitative easing and as the larger Asian economies enter a more mature phase it is worth considering the often hidden potential of income strategies within Asian markets as a means to identify investment opportunities.
Some income-focused strategies have been among the most consistent performers in emerging markets and Asia over the past decade. We note that value strategies, including those of dividend yield and cash flow yield, have had more consistency and reward for risk than those based around chasing high growth or high returns in Asia.
Tracking the importance of the dividend component to total return shows that, its contribution has been steadily increasing through the past decade, such that it now rivals earnings as the biggest driver of the total return, as shown below.
Demanding a certain level of income puts something of a cap on acceptable valuations, a key consideration given the prior success of value strategies. It also guards against chasing expensive growth stories and overpaying for them.
At AMP Capital we employ a bottom up investment process with a mix of qualitative and quantitative factors. A key part of the quantitative side is a robust quant value model that includes factors such as forecast dividend yield and four year historical dividend growth, as a way of explicitly ranking companies and better sharpening the opportunity set.
Furthermore, it also makes company management watch the cash. Firms that had a record of paying a decent share of their earnings as steady, sustained dividends tend to be more prudent and less inclined to squander shareholder funds.
Developed markets are commonly perceived to have more fertile opportunities for income investing given higher returning and more mature companies. However, as shown below, dividend growth has actually been higher in many emerging markets over the past decade.
While there is a low base effect at play here to a certain extent, income strategies or dividend yields have proven to have greater sustainability in emerging markets than developed markets.
Source: Factset Alpha Tester, CLSA Asia Pacific as at October 2013. MSCI-weighted US dollar total return with monthly rebalancing. Past performance is not an indicator of future performance.
CLSA have done some interesting work which shows the performance differential of the highest quintile dividend yield stocks (versus lowest quintile and market) has been significantly greater in emerging markets than developed markets over the past 10 years, with a wider divergence in emerging markets over the past five years.
One of the key differentiating factors behind high-dividend-yield stocks performing significantly better in emerging markets since the global financial crisis than developed markets during 2007-10, was that they were lower-quality stocks, particularly from Europe, with unsustainable dividends such as the financials.
But emerging-market stocks have outperformed even during the significant 2009 upmarket.
However, the sustainability of higher dividend payouts, particularly coming out of high growth periods, needs to be considered.
Within Asia, income investing has had good results across most of the major markets with good performance differentials across 5 and 10 years. This would surprise some in markets such as China where earnings or revenue growth is often seen as the key driver.
High GDP growth has not necessarily translated into good stock market performance, so investors have preferred those companies that have grown earnings and dividends sustainably.
The family nature of some Asian companies (distributing rewards), and the funding needs of governments via dividends from State Owned Entities (SOEs) have also been powerful forces behind increasing dividend streams.
That said, investors need to be aware that high-yield strategies can face headwinds such as expensive valuations, rising bond yields and increased presence of value traps in a low-growth environment. ASEAN markets in particular had an early warning signal of these factors on the first tapering fears in May this year. So such strategies need to be carefully considered and executed.
Accordingly, we believe, considering income investing within the context of a wider value strategy can produce sustainable outperformance in Asian markets.
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