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06.04.2017 | 14:19

Henderson: Earnings upgrades bode well for Asian dividends

The performance of many income strategies has suffered over the past six months. However, Michael Kerley, co-manager of the Henderson Asian Dividend Income Strategy, believes the prospects for income investing in Asian stocks are improving. Here, he explains the reasons for this and details how his portfolios are currently positioned to best capture attractive opportunities in the region.

The last six months have proven to be quite a difficult period for income strategies. The improvement in global growth prospects, rising inflation and the expectation of higher interest rates has prompted investors to switch from defensive stocks to cyclical growth and from defensive yield to value.

Positive earnings revision

Despite this backdrop, there still are reasons to remain optimistic on income investing in Asia. Economic growth in China and the rest of the region is showing encouraging signs and we expect this to continue through 2017. More importantly, this is flowing through into earnings, which are showing the most positive broker revisions since 2009. Although a degree of this is attributable to the highly cyclical materials and commodity sectors recovering from a low base, there are encouraging signs that the breadth is widening to other areas such as industrials, consumer discretionary and financials. This improving earnings picture is helping to keep stock valuations at attractive levels despite rising share prices.

Henderson Global Dividend Index - Asia Pacific ex Japan vs Global

Source: Henderson Global Dividend Index February 2017 edition. Data at 31 December 2016. Yields may vary and are not guaranteed.

Dividends remain a compelling reason to invest in Asia. Asian companies continue to produce impressive amounts of free cash flow and with investment constrained by opportunity, we expect dividend payout ratios (percentage of earnings distributed to shareholders in the form of dividends in a year) to rise considerably over the coming years from the current low levels. This leads us to believe that dividend growth in Asia will outstrip earnings growth compounded over the next five years.

According to the Henderson Global Dividend Index (February 2017), total global dividends* barely grew in 2016 (+0.6%). However, the Asia Pacific ex Japan region posted solid dividend growth (see chart) of 4.8% on a headline basis, with South Korea and Taiwan seeing dividends soar by a fifth in underlying terms.**

Positioning for dividend growth in Asia

The Asian Dividend Income strategy retains its 50/50 split between high yield and dividend growth stocks. High yield tends to be focused in the more developed markets while dividend growth is typically in developing markets. The only exception to this is South Korea where corporate governance changes should drive much higher dividend payouts over time. This is the reason we are overweight South Korea, the lowest yielding market in the region.

Although the high yield holdings in our portfolios have been a drag on the strategy's performance over the past six months, we retain exposure to telecoms and real estate investment trusts (REITS) as the sectors' yield premiums over bonds and cash are expanding (ie. prices have fallen more than yields have risen), which to us currently represents a compelling investment.

Other favoured sectors are technology, where we have large positions in Chinese internet group, NetEase, Samsung Electronics, Taiwanese electronics contract manufacturing company Hon Hai Precision, and energy where we are positive on refiners SK Innovation in South Korea and Star Petroleum Refining Company in Thailand and beneficiaries of lower gas prices such as Thai oil and gas group, PTT. At the country level we are positive on the prospects for South Korea, Singapore and China although the latter remains an underweight position owing to the ever increasing index weight of companies such as Tencent and Alibaba, which, because of their high valuations and focus on growth are not suitable holdings for an income portfolio.

Outlook

The outlook for Asia remains one of attractive medium to long term growth, structural reform and compelling valuations. This is coupled with positive prospects for dividend growth given that Asian companies are generating ever increasing amounts of free cash flow, while dividend payout ratios are set to rise from historically low levels.

While the risks to these expectations are numerous, they are focused mainly on western markets rather than in Asia. Upcoming elections in Europe and the potential for protectionist policies from the US are clear worries while the strength of the Chinese recovery beyond the end of this year is another area of concern. The biggest risk in the short term, however, is that market valuations in the US and several other western markets have reached multi-cycle highs despite considerable macroeconomic and political uncertainty. A market pull back is probably overdue, which could cause increased volatility in global markets. We stand poised to utilise any period of weakness as an opportunity to pick up our preferred stock targets at more attractive prices.

The performance of many income strategies has suffered over the past six months. However, Michael Kerley, co-manager of the Henderson Asian Dividend Income Strategy, believes the prospects for income investing in Asian stocks are improving. Here, he explains the reasons for this and details how his portfolios are currently positioned to best capture attractive opportunities in the region.

The last six months have proven to be quite a difficult period for income strategies. The improvement in global growth prospects, rising inflation and the expectation of higher interest rates has prompted investors to switch from defensive stocks to cyclical growth and from defensive yield to value.

Positive earnings revision

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Despite this backdrop, there still are reasons to remain optimistic on income investing in Asia. Economic growth in China and the rest of the region is showing encouraging signs and we expect this to continue through 2017. More importantly, this is flowing through into earnings, which are showing the most positive broker revisions since 2009. Although a degree of this is attributable to the highly cyclical materials and commodity sectors recovering from a low base, there are encouraging signs that the breadth is widening to other areas such as industrials, consumer discretionary and financials. This improving earnings picture is helping to keep stock valuations at attractive levels despite rising share prices.

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Henderson Global Dividend Index - Asia Pacific ex Japan vs Global

Source: Henderson Global Dividend Index February 2017 edition. Data at 31 December 2016. Yields may vary and are not guaranteed.

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Dividends remain a compelling reason to invest in Asia. Asian companies continue to produce impressive amounts of free cash flow and with investment constrained by opportunity, we expect dividend payout ratios (percentage of earnings distributed to shareholders in the form of dividends in a year) to rise considerably over the coming years from the current low levels. This leads us to believe that dividend growth in Asia will outstrip earnings growth compounded over the next five years.

According to the Henderson Global Dividend Index (February 2017), total global dividends* barely grew in 2016 (+0.6%). However, the Asia Pacific ex Japan region posted solid dividend growth (see chart) of 4.8% on a headline basis, with South Korea and Taiwan seeing dividends soar by a fifth in underlying terms.**

Positioning for dividend growth in Asia

The Asian Dividend Income strategy retains its 50/50 split between high yield and dividend growth stocks. High yield tends to be focused in the more developed markets while dividend growth is typically in developing markets. The only exception to this is South Korea where corporate governance changes should drive much higher dividend payouts over time. This is the reason we are overweight South Korea, the lowest yielding market in the region.

Although the high yield holdings in our portfolios have been a drag on the strategy's performance over the past six months, we retain exposure to telecoms and real estate investment trusts (REITS) as the sectors' yield premiums over bonds and cash are expanding (ie. prices have fallen more than yields have risen), which to us currently represents a compelling investment.

Other favoured sectors are technology, where we have large positions in Chinese internet group, NetEase, Samsung Electronics, Taiwanese electronics contract manufacturing company Hon Hai Precision, and energy where we are positive on refiners SK Innovation in South Korea and Star Petroleum Refining Company in Thailand and beneficiaries of lower gas prices such as Thai oil and gas group, PTT. At the country level we are positive on the prospects for South Korea, Singapore and China although the latter remains an underweight position owing to the ever increasing index weight of companies such as Tencent and Alibaba, which, because of their high valuations and focus on growth are not suitable holdings for an income portfolio.

Outlook

The outlook for Asia remains one of attractive medium to long term growth, structural reform and compelling valuations. This is coupled with positive prospects for dividend growth given that Asian companies are generating ever increasing amounts of free cash flow, while dividend payout ratios are set to rise from historically low levels.

While the risks to these expectations are numerous, they are focused mainly on western markets rather than in Asia. Upcoming elections in Europe and the potential for protectionist policies from the US are clear worries while the strength of the Chinese recovery beyond the end of this year is another area of concern. The biggest risk in the short term, however, is that market valuations in the US and several other western markets have reached multi-cycle highs despite considerable macroeconomic and political uncertainty. A market pull back is probably overdue, which could cause increased volatility in global markets. We stand poised to utilise any period of weakness as an opportunity to pick up our preferred stock targets at more attractive prices.

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