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Asia high dividend strategy: A new way forward in a low rate environment

In this article, Sanjiv Duggal and Alexander Davey discuss about the virtues of investing into Asia high dividend at this point in the market cycle.
21 April 2020
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    Key takeaways:

    • Asian markets have corrected sharply as the novel coronavirus spread around the world. We expect a significant contraction in economic and earnings growth
    • The attractiveness of an Asian high dividend portfolio is magnified in this low interest rate environment
    • An Asian high dividend portfolio is well-positioned to provide investors with an attractive yield during these challenging times, along with the opportunity for capital gain when the economy recovers
    • Our high dividend portfolio normally invests in better quality companies with good business models that generate positive cash flows and  strong balance sheets.  In fact, about two-thirds of our portfolio (excluding our cash holding) has net cash positive balance sheets, barring financial companies.
    • Examples of companies we find attractive: the world’s largest semiconductor foundry, a premium beer market leader in China/Asia, the world’s leading memory company, the largest REIT in Asia, the leading life insurance companies in both Asia and China, and the largest telecom operator in Indonesia

    What should we make of the sell-off in the equity markets in March?

    Equity markets are wary of unexpected events. The uncertainty resulting from the spread of the novel coronavirus (COVID-19) – first across Asia and then around the world – led to large-scale market panic.  The Asian equities lost nearly one-fourth of its capitalisation at the worst point of the brutal and rapid market correction in March 2020, with some stocks falling more than 50%. Adding to the negative news flow was the feud over oil production between Russia and Saudi Arabia, which ignited a significant price drop in the commodity and also weighed on the equity market.

    Fig. 1: Just like global equities, Asian equities have taken a beating in March 2020
    Year-to-date total returns

    Fig.  1: Just like global equities, Asian equities have taken a beating in March 2020

    Source: Bloomberg, MSCI, as of 17 April 2020

    Whilst more bad news around the spread of the virus or its impact on the global economy could spark further falls, we believe that the equity markets may have priced in much of the current pessimism. China, having been the first to confront the coronavirus, has now begun returning to work and  reclaimed some degree of normalcy.  Interestingly, its market is also one of the better performing ones this year.

    Lockdowns, social distancing and other restrictions have caused a severe slowdown in economic activity and a massive jump in unemployment globally.  However, unprecedented fiscal and monetary measures by governments and central banks across the world should partially mitigate pandemic’s impact on the global economy and move us closer to an eventual recovery.

    The prospect of low oil price is favourable for Asian countries, as all of them are net oil importers apart from Malaysia.  With that said, our Asian equity  high dividend portfolio is not invested in the oil & gas industry.

    Why should investors consider Asia high dividend at this point in time?

    Given the aggressive monetary stance taken by central banks, interest rates will remain low for quite some time. This low interest rate environment is likely to reward better quality dividend yield plays, as  investors remain keen to identify opportunities that can provide a reasonable stream of income whilst maintaining exposure to potential capital gains from an eventual economic recovery.

    Fig. 2: Asian equity dividend yields are higher than most government bond yields

    Fig. 2: Asian equity dividend yields are  higher than most government bond yields

    Source: Bloomberg, MSCI, data as of 20 April 2020.
    Note: Equity index’s dividend yield is on a 12-month trailing gross basis

    Compared with their peers in the US and Europe, Asian equities may have greater potential for long-term future price gains at this point in the cycle. From a macro-economic perspective, the GDP growth of Asia should continue to be higher than the US and Europe over the coming quarters, even taking into account the considerable headwinds we have seen so far in 2020.

    Viewing Asia relative to other equity markets, Asian equities look inexpensive, with many companies trading at lower price-to-book (PB) multiples than those in markets such as the US. Asia high dividend is therefore in a great position to provide investors with an attractive yield and to help them capture some of the rise in stock prices once the economy recovers.

    How are you positioning in this market of heightened volatility? Are there any risk factors investors should watch out for in this market? 

    It is very important to remain disciplined during bouts of heightened market volatility and to avoid taking spontaneous, reactive decisions. Having taken a prudent investment approach, we remain comfortable with our portfolio, although we were surprised by the very sharp negative performances of a handful of positions.

    However, because we believe in the soundness of these positions, we continue to hold them – for a few of these stocks, we have even been doing some bottom-fishing.  Interestingly, a couple of these companies have announced buybacks and one has raised its dividend payout ratio on a sustainable basis. We take some comfort from the fact that the consolidated balance sheet of corporate Asia is stronger than other regions such as Europe and the United States. Around two-thirds of our portfolio (excluding our cash holding) has net cash positive balance sheets, barring financial companies.

    As prices fall during a market decline, it’s very typical to see an increase in the number of potentially attractively valued stocks, but one also has to be careful not to mistake value traps for bargains. A drop in a company’s price would make its dividend yield go up by definition, but the yield is only as reliable as your estimate of the company’s future earnings. It could be possible that the deterioration of economic conditions, which is what that has caused stock prices to fall in the first place, has also compromised certain companies’ ability to continue to stably and reliably make dividend payments to their shareholders. Additionally, we have begun to see government and regulatory intervention in some sectors, such as financials, which may impact dividend payments in the short term.

    To guard against such uncertainty around the receipt of dividends, investors would be better served to think defensively and pay closer attention to stocks that have a proven track record of maintaining dividend payments under unfavourable market conditions.  On a positive note, Asian companies, compared with peers in the United States and Europe, in general have less debt relative to equity and cash, allowing them to be able to more easily fulfill dividend commitments to their shareholders.

    Fig. 3: Asian equities’ forward dividend yield spiked up at the very time when the market sell-off was at its worse
    Forward dividend yield (%)

    Fig. 3: Asian equities’ forward dividend  yield spiked up at the very time when the market sell-off was at its worse

    Source: Bloomberg, MSCI, as of 17 April 2020

    Where do you see investment opportunities and pitfalls in the current environment?

    Our strategy currently has a significant overweight in the communication services sector. The telecom companies in this sector appeal to us because we believe they should  enhance the defensive and income characteristics of our portfolio.  We typically invest in market leaders who tend to have better balance sheets.

    We have begun to see government and regulatory intervention in some sectors, particularly financials.  Such intervention will have an impact on the ability of banks to conduct buybacks or pay dividends.   Banks’ profit margins will be under pressure from low interest rates and rising credit costs.  We are currently neutral on banks but we are considering going underweight.  Within financials we retain our overweight on life insurance companies because of the structural growth opportunities we see in this industry.

    We also hold a positive view on the 5G and connectivity theme.  Our strategy is invested in two global leading technology names that should benefit from the deployment of 5G and the demand for associated products and services.  Both these companies are net cash positive, with one of them having announced a buyback in March.

    We see a connection between the 5G proposition and the China demand recovery theme, as China will be a key driver behind the deployment and utilisation of the technology.  Similarly, cement stocks in China are also a part of the China recovery theme.

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