The broad global expansion that began about two years ago appears to have plateaued and is becoming more uneven.

Analysts have been revising down their earnings forecasts in selected markets on concerns that trade tensions and political uncertainty in Europe as well as Latin America will hurt investments, hiring and ultimately global growth. Emerging Markets have been the hardest hit - analysts have downgraded earnings forecasts for 19 consecutive weeks, since early April. See Figure 1.

Fig 1. Emerging Markets - Weekly earnings revisions1


As the earnings outlook turns more hazy, dividends potentially offer investors a source of stability. Company management is less inclined to cancel or reduce a dividend - which can be an adverse signal to markets, as investors often view dividends as a reflection of a company’s operations and financial condition. The ability to pay out dividends is also a sign of strong and stable cash flows. Figure 2 shows how Asian dividends have historically been more stable than earnings.

Fig 2. MSCI Asia Pacific ex Japan – Dividends versus Earnings2


Still in favour?

High dividend yielding stocks benefitted from strong investor demand following the “search for yield” post the Global Financial Crisis. With the Federal Reserve (Fed) expected to continue raising interest rates, albeit gradually, into 2019, will higher rates weigh on the performance of dividend yielding stocks? On this front, it is interesting that analysis on high dividend yielding US stocks from 1927 to 2015 showed that these stocks performed better when interest rates were low and rising, than when interest rates were low and declining3.

In Asia, we divided the Fed’s rate hike cycle since 1999 into five distinct episodes. See Figure 3. During these episodes, the MSCI Asia Pacific ex Japan High Dividend Yield Index delivered positive returns as long as the Fed Funds rate was below 6%, with the exception of May 1999 to April 2000, during the dot-com bubble, where the Index fell by 1%.

Fig 3. Total returns during Fed hiking cycles (1999 – 2018)4


Over the next 18 months, we expect US short-end rates to increase by 75-80 basis points as the Fed continues with policy normalisation. Over in Asia, rate hikes are expected to be even more gradual.

The appeal of Asian dividends

Higher dividend paying stocks outperform over the long term and help buffer capital losses especially during down markets. During the market corrections in 2008 and 2011, the MSCI AC Asia Pacific ex Japan High Dividend Yield Index outperformed the MSCI Asia Pacific ex Japan Index by 7.3% and 10.7% respectively. Research by MSCI showed that from December 1998 to August 2015, high dividend yielding stocks in the emerging markets performed better than their counterparts in the developed markets as investors regard stable income to be a safe harbour against local economic and currency risks5.

The good news is that Asian companies have been paying out more dividends. Dividends accounted for 65% of the total returns from Asian equities from 2008 to 2018, up from 39% in the prior 10 years. See Figure 4. This percentage surpasses the developed markets where dividends account for 30% and 48% of total returns in the US and Japan respectively. Europe is a close second at 62%.

Fig 4. Breakdown of total returns (July 2008 – June 2018)6


Asia’s rising dividends are the result of stronger cashflows and healthier balance sheets. Figure 5 shows Asia’s net debt to Earnings before Interest, Tax, Depreciation and Amortisation (EBITDA) falling from 2.6x in 2001 to 1.96x in 2017. During this period, Asia’s dividends per share grew by 239%. With Asia’s net debt to EBITA expected to fall further to 1.7x going into 20197, the outlook for dividends appears bright. Looking at net debt to equity, Asia ex Japan stands at 29%, much lower than the developed market’s 56%8.

Fig 5.Asia net debt to EBITDA9


Besides a steady income stream, Asian dividend stocks can also offer global investors greater diversification. Asia’s high dividend yielding stocks have a different profile compared to their counterparts in the developed markets. See Figure 6. While high dividend yielding stocks are commonly associated with sectors with strong cash flows but poor growth prospects, e.g. utilities and telecommunications, this is not necessarily the case in Asia. Active managers such as ourselves have also been able to identify high yielding stocks in other sectors including technology and industrials.

Fig 6. Top 3 sectors in high dividend yield index10


More to come…

There is room for dividends to grow further in Asia. For one, although Asia’s dividends per share grew 14% in 2017, surpassing dividend growth in the US (7%) and Europe (4%), Asia’s dividend pay-out ratio (42%) is still below that of the developed markets (~50%)11.

Two, structural drivers are in place to accelerate dividend growth. In our earlier article, we highlighted that South Korea, Taiwan, Hong Kong and Singapore are projected to have the largest share of elderly population by 2050, with more than 4 in 10 persons aged 60 and above. The need for adequate and diversified sources of retirement income will underpin the demand for high dividend yielding stocks. Asian company management are likely to rise to the challenge.

In South Korea, the National Pension Service (NPS) adopted a stewardship code in July. The code aims to make institutional investors more engaged in corporate governance issues in the interests of their beneficiaries. This may lead companies to pay out bigger dividends. Other institutional investors may also follow in NPS’ wake, exerting further pressure on Korean company management to increase dividend pay-outs. Not just in Korea, corporate governance is likely to become more important over the next decade in Asia.

Over in China, as reforms stay in place, we can expect to see more Chinese companies running their businesses with clearer goals to improve shareholder returns. The recent development of employee share option schemes even within state-owned enterprises help align management incentives with shareholder returns, improving the prospects for sustainable dividends.

Bottom line

Asian equities look cheap relative to Europe and the US - Asia is trading on a price to book of 1.6x versus 3.4x and 1.8x for the US and Europe respectively12. If history is a guide, Asian markets typically perform well over the next 1, 3 and 5 years when Asian market valuations are at these levels.

It remains to be seen whether investor fears of slower growth and weaker earnings will materialise. Markets nevertheless are likely to be sensitive to news flow and economic data releases for the rest of 2018. This points to more, not less, volatility going forward.

Asian dividends allow investors to take advantage of Asia’s attractive valuations while enjoying some defensiveness in their portfolios. Investors however need to steer clear of companies that have an unsustainably high pay-out ratio or volatile pay-out policies. Active managers can help investors avoid “yield traps” by examining the underlying drivers of a company’s dividend yield, thereby identifying quality companies with sustainable dividends and dividend growth.

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