Industry Voice: The sell-off in emerging markets this year has created a more favourable environment for Asian income funds, allowing them to deliver strong returns relative to the index and display their ability to mitigate risks to investors' capital.
By their nature, income funds tend to have lower beta than market peers, so the last two years have been difficult for income investors as markets have performed very strongly. But when markets are moving sideways or falling, it is easier for them to outperform.
In part, this is a result of the natural defensive qualities they offer through dividend yields, which can insulate a fund from price falls. Additionally, the types of companies invested for income tend to be more robust, more defensive, and less likely to spring nasty surprises.
One of the key features of emerging market crises is the risk of currency falls, and we have seen examples of the fallout of this in Indonesia and India this year. For me, as an income investor, currency woes mean I have to look for opportunities that are intrinsically stronger. With this in mind, I take my cue from the bond markets. In many instances, if a country's bond market is worried about the currency investors tend to see a sell-off in the asset class and much higher interest rates will follow.
With this in mind, I choose to invest in markets where 10-year government bond yields are lower than in the US. This is a good starting point for me, because it means the country and currency are less vulnerable to shocks.
Currently such opportunities can be found in four key Asia Pacific countries - Singapore, Taiwan, Hong Kong and Australia. All of these have 10-year government bond yields lower than the US: Hong Kong at 2.34%, 0.84% in Taiwan, Singapore at 2.54%, and 2.70% in Australia*.
For some people, this may seem like an odd allocation given the fact they are all ‘developed' Asian markets. But I believe the ‘emerging versus developed markets' argument is a slightly old-fashioned one. If bond markets are pricing risk at a better rate than that of the US, it shows confidence in monetary and fiscal policies as well as the rule of law in a country, all factors which I consider important when deciding to invest in a country.
Conversely, I currently avoid countries such as India, which has a 10-year bond yield of 8.1%, Indonesia at 8.1%, Pakistan with 10%, and the Philippines at 6.7%*. With such high returns risk-free, investors must be very confident of the outlook for equities in these countries to invest in them.
One sector that I am particularly confident in is entertainment, including tourism. There is a structural growth story here as the mobility of people continues to expand. The sector is relatively immune to automation; other sectors may get hollowed out as a result, but people will have more and more time for entertainment.
An example of a rapidly growing industry is e-sports, and in five to ten years' time investors will see things in this area that we cannot imagine today. Who knows, maybe it will become an Olympic event. And it is easy to see how companies that operate in the entertainment sector will benefit from this growth.
At the moment, we play this theme mainly through airports and casinos, and through our holding in Tencent, the biggest computer game platform.
Over the last couple of decades, the investible universe for Asian income has doubled. In 2001, the number of MSCI constituents with a payout ratio above the average of 40% was 160, and by the end of 2017 there were over 300**.
Over time, I expect dividend growth in the region to be closely aligned with nominal GDP growth, so in local currency terms we feel we should be able to see dividend growth of 5% a year over the next few years.
* Bloomberg. As at: 24.09.18
This article is for informational purposes only and is not investment advice. Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested.
The views expressed are those of the Fund Manager at the time of writing, are not necessarily those of Jupiter as a whole and may be subject to change. This is particularly true during periods of rapidly changing market circumstances. Every effort is made to ensure the accuracy of any information provided but no assurances or warranties are given.
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