Mention income and most investors will naturally think of “UK blue-chips”. But, as I pointed out earlier this year, red lights have been flashing over many of the FTSE 100’s staple dividend payers. As expected, the apparently generous yields on offer were too good to be true and we have seen a vicious dividend cull among the UK’s top flight equities.
Given the concentrated nature of the UK’s dividend payers, this is going to hurt. Have a look at the top 10 holdings of most UK equity income funds, and the chances are you will see the same company names appearing again and again. This problem of “dividend clustering” is well documented, as the bulk of UK income comes from an increasingly concentrated pool of companies. According to the latest Capita Dividend Monitor, more than half (55 per cent) of UK dividends were paid by only 15 companies.
So where else might yield-hungry equity investors look? Step up Asia — a region that boasts a far larger, more diversified pool of dividend payers than you might expect. Some 95 per cent of the companies that make up the MSCI Asia Pacific ex-Japan index today pay a dividend. Indeed, scour the globe and you’ll find Asia leads the pack when it comes to offering the income investor’s holy grail: income and growth.
Analysis by Liontrust Asset Managers found 165 companies in the Asia-Pacific region (excluding Japan) offering both a prospective dividend yield of more than 4 per cent and future earnings per share growth above 10 per cent. That compares with only 33 companies in the UK, 62 in continental Europe and a measly two in Japan. In fact, only the US pips Asia to the post, and by a very small margin, with 174 companies there offering that level of income and growth.
This isn’t a new story. Wind the clock back two decades (a period that includes the ferocious Asian financial crisis) and an investment in the region’s equities via the MSCI AC Asia Pacific ex-Japan index would have generated a total return (income plus capital growth) of 155 per cent by the end of March 2016. Without dividends reinvested that number comes to a far less impressive 42 per cent as the chart below shows.
Mark Williams co-manages the Liontrust Asia Income Fund, which pays a quarterly dividend and boasts a not-too-shabby net yield of 5.2 per cent. He says that what has changed over the past decade is China’s arrival at the dividend party. He sees an increasing number of private companies demonstrating greater financial understanding and a willingness to return cash to shareholders.
Meanwhile, new government policies in the form of tax incentives discouraging cash hoarding are prompting South Korea’s biggest family-run conglomerates, or chaebol, to start sharing their huge cash piles.
In Singapore, the first real estate investment trust (Reit) was listed in 2002. Today, the stock market has been transformed by these property income payers. Listed Reits make up 9.5 per cent of Singapore’s total market capitalisation, with yields of around 6-7 per cent.
Of course, Asia is not without its concerns for investors, whose love affair with emerging markets has come to an abrupt end. Topping the list of worries is China, even if fund managers tend to be relatively sanguine on China’s slowing growth and rising debt. It clearly cannot continue at the double-digit growth pace of recent years and, while debt has risen substantially, it is not materially higher than in most developed nations.
Of greater concern, however, is the rising tide of money flowing out of the country, which means the government is running down its reserves quickly to support the currency. Capital outflows, in turn, are exacerbated by a weaker currency. It all becomes a self-fulfilling prophecy; people think the currency will fall, so they sell, and lo and behold it does fall. The same vicious circle was experienced during the years of renminbi strength from 2010 to 2013 when inflows made it a one-way bet in the other direction, encouraging in-flows that caused the currency to rise.
For investors to stay positive on China these outflows have to decelerate. If capital outflow turns into capital flight, it gives a clear sign the government has lost control of the capital account.
China is clearly navigating a perilous path towards a liberalised financial system but there is plenty of good news too. Manufacturing is moving rapidly up the value curve and services now account for the largest slice of the economy.
Unless the economy really melts down, there is money to be made by backing the consumer-driven elements of the economy and avoiding the areas where excessive investment has resulted in overcapacity and lack of pricing power. China’s one-child policy might create future headaches in the form of a shrinking workforce but, as it stands, it means new entrants are immediately sucked up into the job market which bodes well for employment figures and boosts wage growth. Most importantly, China’s stock market is cheap.
Despite short-term hiccups, Asia’s long-term story remains intact. The region still has a normally functioning monetary policy, unlike parts of the developed world that are experimenting with negative interest rates. Asia’s relatively high interest rates gives it monetary fire-power, coupled with robust fiscal spending potential.
Finally, it’s worth noting that the Asia-Pacific region includes Australia, New Zealand, China, Hong Kong, Taiwan, South Korea, Singapore, Thailand, Malaysia, Indonesia, the Philippines and India. Although connected by geography, there are significant political, economic and corporate differences between these countries. This variety gives experienced active investors opportunities to improve returns.
The list above only includes the countries that make up the MSCI AC Asia Pacific ex Japan index, and the argument would be further strengthened by adding the “frontier markets” of Bangladesh, Sri Lanka, Vietnam, Myanmar and Pakistan, which active managers in this space can also tap into.
Ideally, you should be investing in Asia to capture total returns, targeting those companies with a combination of income (the immediate filter to ensure management quality and financial understanding) and growth (to capture the region’s ongoing, although decelerating, expansion).
This doesn’t mean simply tracking the highest-yielding companies, but often looking for those with middling yields expected to grow over time. But this is nigh on impossible to do without active, experienced stock selection.
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