193. Investing for income in Asia

12 May 2022 (pre-recorded 5 May 2022)

Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.

[INTRODUCTION] 

Staci West (SW): Welcome back to the Investing on the go podcast brought to you by FundCalibre. Richard Sennitt joins us today from Schroders to give his views on China, inflation and whether dividend growth can ultimately keep up with inflation in Asia. 

Chris Salih (CS): I’m Chris Salih and today we’re joined by Richard Sennitt, manager of the Elite Rated Schroder Oriental Income fund. Thank for joining us today, Richard. 

Richard Sennitt (RS): Thank you very much for having me. 

[INTERVIEW]

CS: Let’s start with China. Could you maybe just talk us through the troubles there and the impact that it might have on wider growth for Asia?

RS: Yeah. So, at the moment, the Chinese economy is being impacted by a series of COVID outbreaks, as you know, this is on top of a slow down last year, which was being driven by a weak property market and increased regulation of many industries. China has obviously stakes a lot on its management of the pandemic and is one of the few places left pursuing a zero COVID policy. 

Unfortunately, the combination of a more easily transmitted Omicron, and a relatively low level of vaccination in the very elderly – despite actually having a high level of vaccination in the wider population – has meant that we are having to resort to a series of rolling lockdowns to control the virus and we’ve all seen coverage of those in places such as Shanghai, for instance. 

This is obviously hitting growth via consumption as people spend less, but differently from the first lockdowns in 2020, it is also hitting production with many factories temporary suspending production and having to close. So this means that we’re seeing many supply chains disrupted and this is not just in China, but globally. The impossible question to answer of course, is how long will this last? But whilst China continues with this zero COVID policy, these rolling lockdowns are going to continue, and this will continue to impact on growth. It should be said to try and counter this, we’ve seen some more [monetary] easing measures coming out from the authorities recently, which should go some way to easing that growth slowdown. 

Looking outside of China. The knock on is likely to be felt by companies that obviously export to China, either to serve the domestic market or to assemble products to export globally. Here, I’m thinking mainly of the Taiwanese and Korean companies. They’re obviously big manufacturers of electronic components and semiconductors and they’ll obviously potentially get hurt by this. 

The other obvious area that could be impacted is demand for commodities. And here, the producers such as in Australia and in Indonesia are potentially hit if we do see a big slowdown. Overall though, what I would say is that although we are seeing a slowdown in China, it is in part being offset by the recovery that we are seeing in global demands that has been coming through as Western economies have opened up post pandemic.

CS: And just turning to your portfolio now obviously, you currently have most of the portfolio invested in companies in developed Asia. Could you maybe tell us why? Is developing Asia not as attractive, perhaps?

RS: No I wouldn’t say that’s necessarily the case. What I’d say is that, I mean, you’re right in that if you sort of look at it, how I suppose you know, we think of developed markets or how at least MSCI define them, we’d say that just over half the portfolio would be in developed markets and they would principally be Australia, Hong Kong, Singapore and of course these areas which traditionally have been very good from a sort of hunting ground from an income perspective. And in particular you tend to find some of the more attractive financials and materials names coming out of those markets. So, for instance, Singapore and Hong Kong banks we think should benefit from sort of what’s going on from an increase in rates perspective, as well as credit costs coming down. And so I continue to like that area. 

And in materials, Australia obviously gives you quite a lot of exposure to some of the better quality resource names that have been generating very strong free cash flow yields and record dividend payments. We like those names, but I have been trimming some of those more recently just simply because they have done very well. So that’s the sort of rationale if you like for that sort of being in some of the more developed areas. When we are looking at the sort of emerging the principles sort of area of underweight there has been really towards China. And that’s because from a bottom up perspective, it’s been quite hard to find names that I particularly like at the moment, and we sort of talked about some of the sort of macro difficulties with China as well at the moment, you know, from an economic standpoint, but also over the course of the last year or two years has been a whole increase in sort of regulatory scrutiny on some of the sort of internet names there and so on, which also has sort of weighed on sentiment. 

So, from a emerging perspective, the sort of focus of the portfolio is more on the sort of Koreas and Taiwans of the world where, along with some of the sort of smaller ASEAN markets like Indonesia. Taiwan is a good sort of market from an income perspective, even though it’s got sort of you know, over half the market is information technology. The companies there generally have got good corporate governance, have got decent payouts and so on. And so I continue to like those names as well. 

One of the sort of emerging markets where I’m unlikely to have much exposure in is in India. And that is just really, because there isn’t much in the way of yields on offer from companies. So it’s quite hard to find sort of income ideas there. And so currently I don’t have any exposure to India within the fund.

CS: Okay. And just from a regional perspective, I believe the last time you spoke to us, you felt Northern Asia was, well, you said Northern Asia was outperforming Southern Asia. Is that still the case?

RS: It’s been quite a change actually over the course of the last year, or so. So you know, so China in particular, and I guess, you know, we’ve talked a bit about China here and some of the problems that it’s facing and that has meant that it has underperformed the rest of the region quite significantly. 

CS: It’s enough to drag it down on its own.

RS: Yes, exactly. So given its weight it’s sort of dragged it down its own. And the other thing that has happened is also that we’ve from this sort of, if you like north Asia versus south Asia, some of the ASEAN markets, this sort of thing has been the sort of rising backdrop of rates going up and a bit more inflation and so on recovery, has meant there’s been a bit of a rotation in the market away from some of the growth names towards more value names. And in particular away from some of those growth names that are perhaps companies, which are loss making at the moment. And the growth is very far out into the future. Those ones have been impacted particularly hard. Whereas some of the companies that have got more earnings visibility and nearer term earning streams have done better. And some of those names are some of what we described, some of the more old economy areas, you know, like those financials names that I mentioned earlier, and you tend to get a higher weighting of those in some of the ASEAN markets. And so those sorts of areas or that area has started to do better vis a vis north Asia.

CS: You mentioned growth and value. They obviously, that’s tied to what’s going on all over the world with inflation. In terms of inflation, is it as big a worry in Asia as it is in the West? Are there any different nuances to it, in that part of the world?

RS: There are one or two nuances. I mean, I think, you know, from an Asian perspective, there’s a couple of things going on. I mean, there’s obviously the direct impact that you get from inflation through rising commodity prices. You know, as I mentioned earlier, the whole of Asia in aggregate is a sort of net importer of commodities. So price rises going through there do feed through and they have a macro impact in that they impact the external accounts of countries. So the trade surplus for instance, is likely to come down. 

But also, from a micro perspective for when I’m looking at companies, clearly input prices are going up. And that means that you’re likely to see a sort of squeeze in profitability of some of these names. So the key for us, when we’re looking at companies, is to try and find companies that have got pricing power, and so are able to pass through price rises to their customers. And so maintain profitability and so on. And so that is a clearly an important factor. And at the moment, you know, there is pressure more broadly as there is globally on earnings and companies that cannot do that. 

The area where I think it’s slightly different from a sort of an Asian perspective versus the West has been more around labour wage rates, where there hasn’t been so much in the way of wage inflation. And I think that’s because they haven’t seen in most Asian countries, what we’ve seen in places like the US, where sort of labour participation rates have gone down a lot, you know, the Great Resignation or whatever, you know, where people have withdrawn from the workforce that hasn’t really occurred. And so you haven’t had some of the shortages in the labour supply that you may have seen elsewhere.

The only other thing I would say about sort of inflation and its impact is clearly there is a sort of secondary round of impact that can come through from inflation, which is more about the impact that it has on real incomes, as input as the cost of living goes up. Clearly there is a pressure on people’s ability to spend on other items and that does have an impact, whether it be, you know, in the West or in the US, or in Asia, on the ability to buy extra product, which potentially is manufactured in Asia. So there is a sort of an impact on consumption clearly from rising input prices.

CS: And specifically on the portfolio here – and I appreciate you have to put your optimist hat on or our pessimist hat on here – can dividend growth ultimately keep up with inflation in Asia, as it stands?

RS: I mean, clearly one of the great attractions of sort of equity income is that it has this ability to grow, which obviously you don’t get in fixed income. And that is obviously dependent on profitability. And I think that clearly, you know, if there is some protection that you can get from inflation through owning those equities, of course, it depends a bit on the rate of inflation and the speed at which that inflationary pressure comes through. Because as I was describing, you can get a short-term impact from a sort of squeeze before you can pass on those rises in commodity prices, but that there is definitely scope to partially offset that rise in inflation through if you like dividend growth through higher profits.

CS: Is that a company-by-company thing, or could there be specific sectors where that’s more likely?

RS: Well, I think it’s a bit of both, but some sectors such as resources and energy names will obviously benefit from rising commodity prices, but it’s actually quite often dependent on the companies themselves, you know, in some companies where they’ve got their particular niche or particular area of specialty that they’re able to push through prices more rapidly, than perhaps may otherwise be the case, often companies that have got quite often, you know, even a company that sells consumer products and you think, oh, there’s not much pricing power there, clearly, it’s very hard for you to push through a price rise, which is just simply I’m going to put my sticker price up and you are going to have to pay more for the same good. 

But if you spend a lot of money or through time on R&D developing new products, as you develop those new products in consumer terms, you can design the new pricing structure in, and you are offering a better product than you did before. And therefore you can start to get back that sort of pricing uprise in raw materials through better pricing on your top line. So yes, there are definitely companies that are better positioned than others to do that.

CS: And just lastly, and I appreciate inflation fits into this to a degree. What would you say the outlook is for dividends in Asia over a three to five year view?

RS: Yeah, so, you know, dividends did come under a bit of pressure during COVID, along with the rest of the world. And this did impact the dividends coming out of companies. We’ve now started to see earnings recover quite materially during the course of last year. And, you know, hopefully we’ll see earnings growth continue this year. And that generally is a reasonable backdrop for dividend growth. And what I would say is that the way to think about it is sort of in the medium term, the sort of dividend growth should be roughly able to grow in line with that earnings growth. 

The other thing which sort of gives me a bit more sort of, which I like about Asia, gives you a bit more confidence around some of the sort of dividends, is that, you know, in general, Asia is an area of the world that from a corporate perspective is less geared than other regions. So the corporates have got less debt on their balance sheets. And that means that as rates rise there’s less pressure on those companies. Also, the payout ratios at the moment – so that’s the amount of the profits that they pay out as dividends – is not particularly high either in an absolute or a sort of historical context. And so that means that there is a bit of ability for companies if you like to defend dividends if things get a bit tougher.

CS: That’s great Richard, thank you very much for joining us today.

RS: Thank you.

SW: The Schroder Oriental Income investment trust aims to provide income and capital growth, primarily through investment in equity and equity-related securities of Asian companies. The trust is named a ‘Next Generation’ dividend hero by the AIC for increasing its dividends for 15 consecutive years. To learn more about the Schroder Oriental Income fund visit fundcalibre.com – and don’t forget to subscribe to the Investing on the go podcast, available wherever you get your podcasts.

Please remember, we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at the time of listening. Elite Ratings are based on FundCalibre’s research methodology and are the opinion of FundCalibre’s research team only.