Many investors have historically viewed Emerging Market (EM) equities as a source of growth, with income a distant consideration. We believe this oversight is a mistake, and that a dividend-focused approach to investing could help boost long-term total returns.
A rich investment pool
Over the last decade, improved economic conditions have resulted in a marked expansion of the EM equity universe; there are now over 3,000 EM companies, four times as many as in 2003. Of those companies, over 90% now pay a dividend, with around one-third paying a yield over 3%. Income makes such a strong contribution to returns over time and has significant compounding effect. Indeed, if we look back over the last 10 years, dividends have accounted for circa 50% of EM total returns.
What’s behind the rise?
As EM economies have grown and matured, companies have increasingly come to understand the benefits of returning excess cash to shareholders. Fast-growing EM firms seeking to attract a more sophisticated investor base have deployed their strong cashflows to pay dividends.
Improved corporate governance, transparency and heightened accountability have fostered better relations between companies and shareholders. After all, a dividend payment speaks to the viability and accountability of company. Combined with an analysis of the underlying cashflow stream of the business, they are also an excellent barometer for measuring a company’s financial health and future prospects.
A diversified source of income
Given the number of Emerging Market MSCI Index companies paying dividends and their large geographical dispersion, EM can provide a diverse income stream. For example, commodities and materials stocks only account for around 15% of companies on the index, down from 50% in 2008. These have been replaced by companies operating in sectors such as telecoms, tech and healthcare.
Onwards and upwards
We think the number of companies paying dividends will rise. A good example is Korea. It has historically been quite conservative in terms of dividend payments – but change is evident and pay-out ratios are increasing. Take the National Pension Service, the world’s third-largest pension fund. It is increasingly using its weight as a major shareholder to encourage better practice when it comes to dividends. Indeed, it recently increased its stake in a number of its investee companies that were paying measly dividends in order to encourage them to up their payments. This includes six out of the 10 companies it has previously blacklisted for disappointing dividend payments.
Government interventions should also see an increase the number of companies that return cash to shareholders. In China, 2017 cash dividend payments hit a record high (over 1 trillion yuan), thanks to efforts by regulators to increase pay-out ratios in the face of investor complaints. This is likely to remain a feature as the US$7.6 trillion stock market becomes increasingly accessible to overseas investors.
Looking through the short-term noise
Investors are often dissuaded by volatility from investing in emerging markets. The recent pronounced sell-off – spurred by rising US rates, the strong dollar and threat of a US/China trade war – has done little to dispel these concerns.
However, we believe too many investors are focused on short-term developments and are failing to capture important medium- and long-term changes in the microeconomic environment. Indeed, we are observing many exciting developments in the asset class, including the emergence of an India housing & infrastructure cycle; the growth of intra-Asia trade; the step-up in China’s tilt towards a consumer-orientated economy; and the burgeoning Internet of Things, with all the productivity enhancements and new industries this technology enables.
These developments are creating numerous investment opportunities from across the EM world. Importantly, EM valuations are now well below their historic average discount to developed markets. The use of a fundamentally-driven income approach could be a good way to capture this EM growth opportunity while still receiving a premium income – making this a potentially compelling investment option in a volatile but appealing asset class.
Author: Matthew Williams, Investment Director at Aberdeen Standard Investments. To find out more about Aberdeen Standard Investments contact your financial adviser.