In particular, we are currently looking to exploit the Asian equity income story that has largely been shunned by Asian investors, who do not place a great deal of store in dividends.
I recently returned from a research trip to Hong Kong and Tokyo, where a key focus was to re-examine income stories in the region. Even in Japan there are currently exciting income plays we can benefit from in our portfolios.
Thomas Becket
Chief Investment Officer, Psigma Investment Manatement
We continue to run an overweight position in Asian equities across our client portfolios. At present, based upon our analysis, it is clear Asian ex Japan equities have higher yields than other global companies, generate higher returns and have lower debt to equity. In addition, Asian companies broadly have progressive dividend policies and boards are recognising the benefits of paying attractive dividends to entice global investors.
Waking to income
It is our belief that in time Asian investors will belatedly wake up to the benefits of income investing, and dividend stocks should re-rate to more appropriate valuations. They are currently low double-digit teen P/E multiples and are expected to reach the higher mid-teens P/E multiples.
The two recent interest rate cuts in China might also encourage the Chinese investor to look towards dividends as an investment strategy. This story might take time to play out and come to fruition, but in certain Asian income strategies you are being paid upwards of 5% pa, which we believe is healthy compensation and a decent option premium.
Our favoured Asian Income funds are the Schroder Asian Income Maximiser Fund, which is diversified across the region and pays out a 7% yield enhanced by covered calls, and Prusik Asian Income. The Schroder fund is run by Richard Sennitt, who has delivered excellent returns to investors over the past few years. The out-performance has come from his defensive stance, which in volatile markets has served him well.
However, on a recent conference call, Sennitt revealed he had been adding to some of the materials and mining stocks in the region, which were now selling at an attractive valuation discount to defensive companies. The fund provides investors with a balanced approach to Asian investing, as well as a very healthy and sustainable yield.
Negate negativity
Summary
• Zero interest rates and historically low bond yields mean looking for income becomes a harder task, especially for equity investors.
• Psigma Investment Management runs overweight positions in Asian equities across the portfolios and even sees income potential in Japan.
• Asian governments and companies are in far better shape with a far lower debt position than their Western counterparts, so it should not be a surprise that Asia also offers strong income opportunities.
The Prusik fund, which we first bought earlier this year, is a clear example of why being overly negative on equity markets at this stage would be the wrong strategy. The portfolio of companies the fund owns is currently trading on a historically low earnings multiple in the low double digits, with the potential for healthy earnings growth in the coming years. At the same time, this collection of stocks that are exposed to the Chinese consumer are paying an income yield of approximately 5.6%.
It would be hard in the absence of a total collapse in earnings or massive dividend cuts to argue that these starting valuation multiples are expensive. The consumer is key to China’s emergence in the next ten years, and how effective China can be at recalibrating its economy away from fixed asset investment towards consumption is a question that needs answering. Given the Chinese’s success at shielding their economy from the worst ravages of the financial crisis in 2008, you would back them to deliver the goods.
Bullish on Japan
An interesting bull case can also be built around the dividend story in Japan. In our view, many Japanese stocks are fundamentally mispriced, as investors are effectively refusing to pay anything at all for any chance of future growth. In some cases they are right not to, particularly given the disastrous record of many corporate managements in Japan.
However, there are some seriously attractive growth opportunities trading at exceptional value. Stock ideas in the auto sector, alternative energy and manufacturing are particularly exciting. Realistic earnings growth of 30% this year, as the economy recovers from last year’s tragic events, should entice investors at a time when many Japanese companies are trading on less than their book value. At 2.2%, the dividend yield on Topix is meagre when compared to some other equity markets, but it is growing each year as companies increase their payout ratios and behave respectfully towards shareholders.
The key point is that when juxtaposed to the roughly 0.8% return on offer from ten- year Japanese government bonds (JGBs), the income story is very attractive, particularly for an ageing, yield-hungry population. At one meeting the manager cited the dividend valuation discrepancy and classed the current market conditions as a ‘reverse bubble’. The fact that, at the peak of the Japanese market in 1989, the yield on the market was 0.4% against 4.5% for JGBs was a stark indication of how negative the fortunes for Japanese stocks have been.
Our favoured way of investing in the Japanese dividend story is to invest in Jupiter Japan Income, run by Simon Somerville, who has delivered consistently solid returns.
Currency trashing
Outside equity markets, we are also attracted to the yields available on Asian bonds, although not those in Japan with pathetic rates of income. We also recognise the next ten years is going to see a race between the global ‘Big Four’, (US, Japan, Europe and UK), to trash their currencies as far as possible, so they can try to revive their manufacturing/export sectors.
Currency debasement will make investing in FX markets extremely challenging. However, one region where we do have confidence is Asia. Strong government balance sheets, rising rates and an increasing financial influence over the world will see Asian currencies rise against their beleaguered developed world cousins in the next decade.
Asia offers potential
Our favoured way of gaining exposure is through the Aberdeen Short Duration Asian Bond Fund. With the 3.1% coupon, which is significantly higher than equivalent bonds in the mature world, you can expect returns of between 7% and 8% pa over the next five years.
In the past, many investors have solely focused on Asian investments for their growth potential. While we think there are still some merits to that argument, our view would be it is time to look to Asia for income. Resilient economies, strong companies, solid balance sheets and a maturing investor base should lead to attractive returns in the next few years.
It might take a while for the capital returns we have enjoyed in the past to return, but at least you are being compensated to wait through high levels of income.
