Well times are at last changing. After years of ultra-low rates, to date the US Federal Reserve has hiked interest rates three times since December 2015, with more expected to follow this year. Inflation meanwhile is close to the 2% level in many countries, with even Japan seemingly moving out of deflation.
But what are the implications for income investors? In an environment of rising interest rates globally, both traditional bonds and bond-like equities – so-called ‘bond proxies’ – appear to carry more risk. And while reflationary environments can be good for growth stocks, we believe there remains enough uncertainty in the world – be it the election cycles taking place in Europe, the protectionist rhetoric in the US or potential global trade wars – to keep investors from rushing to reposition just yet.
So what is the best solution in these conditions? In an uncertain environment where rates are likely to rise, we think investors should focus on total return by investing in companies that offer attractive dividends relative to their share price and can demonstrate the ability to grow their underlying dividends in a sustainable manner. Because these companies generate sufficient cash flow to fund dividend payments and allocate capital prudently, they tend to have stronger corporate governance than their peers, and often deliver attractive capital appreciation as well as income.
Asia is an extraordinarily diverse region. It is home to frontier, emerging and developed markets, and there are dividend-paying companies throughout the region. Today the region’s equity markets have grown to represent nearly 40% of global stock market capitalisation, while dividend payments have grown to about $286bn, which is approaching the size of the dividend pool in developed Western markets.
Indeed if you look at the underlying growth of the dividend pool in Asia, it has grown almost twice as fast as that in the US and has been four or five percentage points ahead of Europe over the past few years. Not only does this explain why dividend investing in Asia has proved popular in recent years, it also goes some way to explain why it should remain the case even if interest rates do rise globally.
The culture of paying dividends is also improving in the region, with countries like Japan and South Korea just beginning to enter the dividend growth area. It is due to this combination of government regulation and investor activism that these countries are increasingly offering opportunities to dividend investors.
We think investors that do not venture beyond established hunting grounds, such as Australia, miss out on opportunities not only in the emerging Asia markets such as Indonesia, Vietnam and China, but also within the more developed countries like Japan and South Korea.
Dividend growers are often small to mid-cap companies that occupy strong market positions in areas such as consumption, services and health care. On the other hand, stable dividend payers are often large-cap, matured businesses in sectors such as telecoms, public utilities, and infrastructure assets. A total-return dividend portfolio focusing on both dividend yields as well as dividend growth could include names ranging from small and mid-caps that may be yielding 2% but potentially growing their dividends at a 15% rate to solid businesses that may deliver a stable and recurring dividend yield 4-5%. This balanced approach seeks to create a portfolio that can benefit from an attractive dividend yield without giving up on growth.
In addition, we believe it is important to focus on the sustainability of the dividend stream. Many Asian equity income portfolios are built with a lot of emphasis on yield, containing high yielding stocks that can have challenging underlying businesses. In our long-term total return approach, we use dividends as an indicator of core earnings growth and strength of the company.
While we can analyse companies, we cannot predict the future. Given the level of uncertainty, a strategy of total return can help income investors weather any upcoming storm. As the contribution of income strategies in Asia has been meaningful over the long term, we believe it can offer a less volatile means to access the faster growing economies in the region while at the same time mitigating risk and providing downside protection.
By Yu Zhang CFA, portfolio manager at Matthews Asia
For Institutional/Professional Investor Use Only
The views and information discussed in this article are as of the date of publication, are subject to change and may not reflect the writer’s current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. The information contained herein has been derived from sources believed to be reliable and accurate at the time of compilation, but no representation or warranty (express or implied) is made as to the accuracy or completeness of any of this information. Matthews International Capital Management, LLC (“Matthews Asia”) and its affiliates do not accept any liability for losses either direct or consequential caused by the use of this information. Nothing set out in these materials is or shall be relied upon as a promise or representation as to the future. Investments involve risk. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. Past performance is no guarantee of future results.