Are dividends the answer to the inflation problem?
Interest rates may be edging upwards, but the average interest rate on a savings account is still...
Launched in 2005, the Schroder Oriental Income fund aims to provide income and capital growth by investing in Asia Pacific companies (including Australia and New Zealand) that offer attractive yields and growing dividend payments.
Having managed the Elite Rated Schroder Asian Income fund since 2001, Richard Sennitt was named successor to industry veteran Matthew Dobbs as manager of this investment trust at the end of 2020.
Here, Richard tells us about the income opportunities available in the region.
“Like a lot of parts of the world, the Asian region has not been without its challenges with slowing growth, Covid-19 lockdowns in China, geopolitics and rising inflation all coming to bear,” said Richard.
“Against that backdrop, income stocks in aggregate have done relatively well against the broader market. This is because investors, in my view, have rewarded those companies with more visible earnings and less stretched valuations, many of whom pay attractive dividends. Given this it is worth reappraising the case for dividend paying stocks in Asia.
“Although the dividend yield of the Pacific ex Japan region at 3.0% is not as high as that of the UK market, it fairs well when compared to most other regions including Japan at 2.4% and Europe ex UK at 2.9% whilst being comfortably above the US at 1.5%.
“Notwithstanding the shorter-term growth challenges, in addition to their higher yields, Asian companies, according to the IMF, are operating in a region that is forecast to enjoy higher economic growth than most other parts of the world over the next five years.
“Now, you may argue that overall GDP growth is not always correlated with investment returns but as an income investor I’m looking for companies who are able to potentially grow their income and dividends over time. Given the choice, I’d rather be doing that in an environment of higher economic growth than lower growth.”
“Although Asia may be less familiar than some other regions for income there are still a large number of decent dividend payers,” continued Richard. “For instance, at the end of May 2022 there were over 400 stocks in the index with a dividend yield over 3%.
“Furthermore, the concentration of income is not as acute as it is in places such as the UK. In the UK under 10 stocks make up 50% of the income whereas for Asia the corresponding number is in the mid 30s. These points are important as it means that for me as an active investor I have choice as to what stocks to buy. It also potentially makes Asia a more resilient source of income as it means investors are less reliant on any single company than they are in the UK.
“In uncertain times the resilience of company dividends is an important consideration. Here a useful measure to look at is the dividend pay-out ratio which is the proportion of earnings paid as dividends. For Asia this ratio is around 40% which compares favourably with that of the UK.
“What this means is that if the economy slows and earnings become more volatile, Asian companies on average have a buffer. We’ve seen over time in Asia that when earnings come under pressure, companies that have a lower pay-out ratio don’t necessarily have to cut their dividends. Instead, this buffer gives them the flexibility to allow pay-out ratios to rise until earnings have recovered.
“There are no guarantees that Asian companies won’t cut dividends despite this if the outlook deteriorates but this combined with the relatively lower levels of gearing amongst listed corporates across Asia means, in my view, that there should be some resilience when it comes to dividend payments.
“During the first phase of Covid-19 through 2020 we did see dividend cuts in aggregate across the region, but this was less than in other markets such as the UK. On a medium to longer term basis, one would expect dividends to follow earnings.
“Finally, it should also be remembered that as an investor in Asian income, fluctuations in exchange rates can have an impact on the size of translated dividends, with a stronger Sterling against Asian currencies acting as a headwind and vice versa.”
“The improvement in earnings that came through last year meant that for many companies across the region dividend payments started to recover after aggregate cuts in 2020,” continued Richard. “As described above, owing to the macro backdrop, there is still a lot of uncertainty as to where these will now go given the unfolding geopolitical events and the continued impact from Covid-19.
“Ongoing upward pressure on input prices and a slower growth backdrop has meant that consensus earnings forecasts for the region have seen revisions down albeit they still currently point to very modest growth this year.
“This continues to warrant a focus on companies with pricing power who are able to reduce the impact of these rising prices. It is worth highlighting that whilst inflation rising faster than expected is not great for equities in the short-term, longer term real asset income sources should look attractive versus fixed income which by definition is unable to grow its ‘income’ over time.
“Taken together,” concluded Richard, “we think these arguments illustrate why longer-term Asian shares are potentially an attractive proposition for income investors looking to diversify their sources of income.”
This information is a marketing communication. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. The views and opinions contained herein are those of the individuals to whom they are attributed and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. Insofar as liability under relevant laws cannot be excluded, no Schroders entity accepts any liability for any error or omission in this material or for any resulting loss or damage (whether direct, indirect, consequential or otherwise). Issued in June 2022 by Schroder Investment Management Limited, 1 London Wall Place, London EC2Y 5AU. Registration No. 1893220 England. Authorised and regulated by the Financial Conduct Authority. UK004627.