A focus on income is no hindrance to delivering capital growth when investing in Asia, according to Matthews Asia’s Yu Zhang, who says investors should not base their expectations for the region on the dividend culture in the developed world.
Most of the stocks that investors rely on for income in the West are more mature, stable businesses, but the downside to this is that they tend to offer limited potential for share price appreciation.
However, Zhang said that while he uses high-yielding defensive companies in the Matthews Asia Dividend fund to generate a consistent income stream, he also holds a number of growth businesses that double up as dividend-paying stocks.
10-year compound annual growth rate of dividends paid
Source: Factset Research Systems, Inc.
“You may ask ‘how come half of the growth stocks pay dividends?’ and we think the reason you see this interesting dynamic has to do with who owns these growth businesses,” he explained
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“With a lot of the listed companies in Asia, especially in the mid- and small-cap space, the original founders continue to own a very meaningful stake. From these shareholders’ point of view, they always want to get paid and the one sure way for them to get paid is to put in place a dividend policy.
“And because of that motivation, the main shareholder is quite aligned with the interests of minority shareholders like us in terms of actually getting paid.”
As a result, one of the first things that Zhang (pictured) looks for when weighing up a potential holding is whether the bulk of the controlling shareholder’s overall wealth is tied up in the company, as he said this sends a strong signal about whether they are willing to put a dividend policy in place.
His process also involves a more quantitative component in which he assesses each company’s financial strength to ascertain whether it can generate sufficient and sustainable cash earnings.
“Because actually that operating cashflow will be the majority of the dividends’ source,” he continued.
“We also care about whether the company’s balance sheet is reasonably managed with a reasonable level of external borrowings. A conservatively managed balance sheet gives a company extra flexibility to maintain and continue paying dividends.
“So all this basic financial analysis will allow us to answer the question of whether this company has the ability to pay.”
Only once a company has met both these criteria – and it is available at the right price – will Zhang make the final decision about whether to invest. However, the manager said it is becoming easier to find companies that fit this bill as more Asian markets open up to international investors and more companies float.
“The underlying universe of Asian equities is expanding at a fairly fast rate and naturally with the expansion of the underlying universe, the number of dividend-paying companies has also been expanding,” he added.
“Today in Asia you are already looking at about 9,000 dividend-paying companies, so that is a fairly significant universe.”
This increase in the number of dividend-paying companies has also led to an increase in dividends paid and Zhang believes it is only a matter of time before they catch up with those in the West.
Asian firms are already paying more than $200bn a year to shareholders, a figure that has been growing at double-digit rates over the past 15 years compared with 5 to 6 per cent from the US market.
However, Zhang said the main reason why income-seekers should consider Asia is for the diversification it can provide to their earnings stream. Figures from AJ Bell show that 10 companies are expected to account for half of all dividends paid by the FTSE 100 in 2019 with oil & gas and mining accounting for a quarter of this amount.
The manager said that while you have “all the usual suspects” paying dividends in Asia, such as utilities, telecoms and financials, there is also a significant contribution from areas such as consumer discretionary and tech.
“These are still relatively fast-growing sectors where people tend not to find as many dividend-paying stocks in the West,” he continued.
“In the Asian context in terms of shareholder motivation, a big part of these fast-growing businesses is they are also already paying dividends.
“You can actually put together a pretty well diversified income-generating portfolio investing not only in stable high-yielding businesses but also in fast-growing businesses. We can also enjoy the underlying growth value of receiving a rising dividend income.”
Matthews Asia Dividend has made 111.91 per cent since launch in April 2010 compared with gains of 89.09 per cent from its IA Asia Pacific inc Japan sector and 86.33 per cent from its MSCI AC Asia Pacific index.
Performance of fund vs sector and index since launch
Source: FE Analytics
The $466m fund has ongoing charges of 1.13 per cent and is yielding 2.93 per cent.
Someone who invested £10,000 into the fund at launch would have received £2,579.13 in income alone over this time.