November 2011

EMERGING MARKETS DIVIDENDS: Standing out from the crowd

ShoesInvesting in emerging markets is no longer all about trying to capture rapid growth, but more with creating a steady income stream from dividends. Stefanie Eschenbacher reports. The search for income has broadened further, with several asset managers launching funds specifically focusing on emerging market stocks that pay dividends. ING Investment Management, BlackRock, Insynergy Investment Management, JPMorgan Asset Management, Charlemagne Capital, Polar Capital and UBS Asset Management have all developed funds targeting dividend-paying companies in emerging markets.  Manu Vandenbulck, lead manager of the ING Emerging Market High Dividend fund, says investments with a stable income component are gaining popularity as market shocks contribute to the focus on risk/return characteristics. Vandenbulck, who also manages a similar fund targeting Europe, says dividends are the largest contributor to the total return of an equity portfolio and the only positive source of returns over time. “This makes a dividend strategy a stable source of return with defensive characteristics,” he says. “Another key element is the competitive advantage of dividends compared with earnings: dividend growth is far less volatile than earnings growth, especially during a period of contraction in the economy.” BlackRock added an emerging markets fund to its existing range of equity income funds, which covers the Asia Pacific region, Europe, global markets and resources.  Insynergy launched its New World Equity Income fund, which aims to achieve high and sustainable income, along with growth for a  maximum total return. Spike Hughes, chief executive officer, says a key factor is that analysts often over estimate earnings growth for growth stocks and underestimate it on dividend-paying stocks. For dividend stocks, this can lead to earnings surprises and share price growth. He also says that although the UK Equity Income sector is huge, many managers run a portfolio concentrated into 20 stocks. Capita Registrars, which monitors the dividend landscape in the UK, has warned of this too. According to its latest UK Dividend Monitor, 15 stocks account for 71% of all dividends paid in the country. Consequently, there is a high degree of overlap in the top ten holdings among UK Equity Income funds and an over-reliance on a few payers. The sector was successful when companies paid dividends, but took a hit when BP, once the biggest dividend payer in the UK, stopped doing so after the Gulf of Mexico oil spill last year. Gareth Maher, manager of the Insynergy New World Equity Income fund, has built his highest sector overweight at 5.5% in exchange traded funds exposures. His top holding is the iPath MSCI India Index ETN, which is linked to the MSCI India Total Return Index. This gives him exposure to India, a country dividend investors have struggled to access. Edward Lam, manager of Somerset Capital’s  Emerging Dividend Growth fund, says although Indian companies are benefiting by suppressed cost of capital, there is not much choice for dividend investors. Though most fund managers insist they are bottom-up stock-pickers, a look at their portfolio breakdowns suggests there are some emerging markets that offer more compelling opportunities for income investors. South Africa and Taiwan feature high on the buy-list, followed by Brazil, Chile and Turkey. Attitudes towards shareholders, regulation and listing requirements all are factors that make some countries more attractive than others. “We often find companies that pay decent dividends in South Africa and those companies tend to be well-managed, too,” says Lam. “South Africa has a long market history and its culture is essentially Anglo-Saxon. Like in the UK and the US, pension funds push for a reliable stream of income so companies pay dividends.” Lam has had significant weightings in South Africa (11.9%) and Taiwan (10.5%) since his fund launched, both countries which have traditionally shown a more favourable attitude towards paying dividends than other emerging markets. “There are interesting opportunities in Taiwan, although the market is more heavily traded by day traders,” he says. “We also ask ourselves why companies are paying dividends. Chinese banks, for example, have been very popular with dividend investors but they pay them because the government is often the major owner.” Such reasons do not merit holding a company, says Lam, regardless of how high their dividend payments are. Shoprite, a fast-growing South African retailer with operations across 20 countries, mainly in sub-Saharan Africa, is a prime example of the kind of company Lam seeks. It has increased its dividend payments in dollar terms every year over the past decade and is growing at double-digit rates. Another of his high conviction holdings is Compania Cervecerias Unidas, a Chilean brewery and beverage company with a relatively dominant market share and high margins. Apart from paying dividends, it is also reinvesting in its own business. Lam expects the development of its product range by including snacks to be a strategic fit for the existing business model. Projit Chatterjee, manager of the UBS Emerging Markets Equity Income fund, is opposed to differently weighting individual names. “Our preference is not to have any single stock contributing too much risk, especially dividend risk, to the portfolio,” Chatterjee says. “The portfolio is broadly equally weighted.” Within emerging markets, many companies are state-owned so are susceptible to interference from local regulatory agencies, Chatterjee warns, adding that this could potentially lead to minority shareholder interests being subverted. His strategy maintains a qualitative overlay process, whereby analysts seek to identify and remove those companies where a dividend may be unsustainable for reasons such as corporate governance, forthcoming acquisitions, or pending litigation. Chatterjee sells stocks when they fall out of quantitative screen or qualitative overlay, adding that this could be driven by any combination of a reduction in dividend yield, valuation and other qualitative factors. Those seeking dividends in other emerging markets are helped by certain listing rules, which require companies to pay out a certain percentage of their net profit to shareholders. Brazilian and Turkish companies are legally obliged to pay out 25% of their net profits in the form of dividends, and Chilean companies 30%. Newton Investment Management offers its Global Higher Income fund as well as its more specialised Asian Income fund, given the investment opportunities in the region. Using a thematic approach, Jason Pidcock, the manager, invests across eleven different countries in Asia Pacific. Australia and Singapore are his top choices, followed by Taiwan and Thailand. Pidcock, who has covered the region for 18 years, says dividend ratios went up significantly between 1995 and 2002. Since 2001, the dividend pay out ratio in the region was more than 40% every year, up from 30% previously, and beating the global average. “The number of companies we can choose from increased, too,” he adds. In 1995, 16% of those listed companies yielding more than 3% per year were in the Asia Pacific region. By 2010, the ratio had gone up by ten percentage points. Global equity income managers, however, say there are still more opportunities globally. Alan Porter, manager of the Martin Currie Global Equity Income fund, says Europe and the UK still yield with 4.5% to 5% more than other regions. North America and Japan yield between 2.5% and 3%, while Asia excluding Japan sits somewhere in the middle. Porter has recently built significant holdings in US companies, even though it is one of the lower yielding markets owing to the dominance of technology companies, most of which do not pay dividends. “There are potentially important changes in the mindset of US companies totalling 57% because a couple of companies, some of them being large ones, are paying dividends for the first time,” Porter says. “This potentially opens up new opportunities for dividend investors.” His investment universe comprises 750 companies, 550 of which are in developed markets. “There are opportunities in emerging markets,” he says. “But investors can also get exposure to emerging markets by investing in stocks listed in developed markets, often at better multiples and with less risk.” An estimated 70% of the earnings generated by FTSE 100 companies, for example, are generated outside the UK. Similarly, some of the biggest dividend payers in the UK have most of their business in emerging markets. Blue chip mining, oil and gas companies listed on the London Stock Exchange have paid out £4.3 billion (€4.9 billion) in dividends to investors in the third quarter of this year, according to Capita Registrars. Royal Dutch Shell, BP and BHP Billiton get most of their business from emerging markets. The arrival of Glencore International, London’s largest ever initial public offering, is likely to keep the miners close to the top of the rankings of UK dividends. Other stocks, such as tobacco, financials and certain consumer stocks, also get most of their business from emerging markets. British American Tobacco, Imperial Tobacco, HSBC, and SABMiller have once again been some of the biggest dividend payers. Similar to developed markets, many telecom and utilities stocks in emerging markets pay dividends. In contrast, Vandenbulck highlights information technology companies and Lam infrastructure companies as dividend payers in emerging markets. Patrick König, a product specialist at DWS Investments, who oversees the global and emerging markets dividend funds, says the key factor is whether companies can still grow. He says some of the telecommunication companies, including large pan-European operators, are among the biggest payers worldwide but their potential is limited. “We tend to diversify our portfolio, allocating to some companies that pay high dividends and some that have the potential to significantly increase their payments,” he says. “Using the traditional approach, there is a risk of building clusters in sectors such as telecommunications and utilities, or in countries like Taiwan and Turkey.” Investing for income, he says, usually tends to be more defensive and risk-averse. Getting the allocation right will be the main challenge for equity income investors in both developed markets, which are dominated by a few big payers, and emerging markets, where choice is still limited. ©2011 funds europe

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