As China reopens, why pick an income strategy?
Yoojeong Oh, Investment Manager, abrdn Asian Income Fund Limited
- China’s reopening has delivered a timely boost to Asia’s economies and financial markets
- Asian exposure needs to weather near-term risks, while also focusing on long-term secular trends
- Dividend investing in Asia does not necessarily come at the expense of growth
China’s reopening has reversed a significant period of weakness for Chinese stock markets and renewed enthusiasm for the Asian region more widely. Amid this environment of greater confidence, is an income strategy the right way to harness opportunities in Asia?
As economic activity resumes with China’s reopening, there are multiple beneficiaries: from the pandemic laggards, such as travel and leisure companies, to consumption related industries, which are benefiting from reviving consumer confidence. The positive effects have spilled over to the export-oriented markets of Taiwan and South Korea, while tourists are also beginning to return to popular destinations such as Thailand.
This underlines China’s pivotal role in Asia’s economic recovery, and its reopening bodes well for the region’s prospects in 2023. In addition, inflationary pressures are not as acute in Asia as in the West. This gives Asian companies a notable advantage and resilience over their Western peers, which are facing rising costs and labour difficulties.
While the operating environment appears to be changing for the better in Asia, investors would also need to consider potential near-term risks. Recovery within China is unlikely to be a straight line, albeit we expect domestic consumption to underpin economic growth this year as the country reaches herd immunity fast. The real estate market is stabilising, and we are monitoring domestic sentiment which, in turn, depends on buyers’ confidence in an economic recovery.
Broader inflation and interest rate concerns are still very real. Persistent inflation and a strong labour market are giving the US Federal Reserve pause for thought when it comes to moderating or ending its cycle of interest rate increases. The global economy remains fragile with recession risks in Europe and the US, while geopolitical tensions could also act as a break on Chinese growth.
More recently, banking turmoil in the US and Europe has caused jitters across markets because of concerns that this could result in tightening funding conditions and potential regulatory squeeze, which in turn, could hurt asset quality, the growth recovery and capital flows in the Asia Pacific. The question is what next and this is why we have always backed the banks that are well-capitalised, well-funded, have conservative underwriting and treasury management, and have not taken unnecessary risks to grow. Our bank holdings may even benefit from a flight to quality for both deposits and maybe even wealth management flows in the case of the Singapore banks.
Against this backdrop, we believe it is vital to position Asian exposure to weather near-term risks, and we believe that a portfolio of quality holdings with sustainable competitive advantages and robust balance sheets, which are less reliant on debt financing and continue to display financial strength, will protect their margins and dividends better even in the face of persistent inflation and a higher rate environment.
Over the longer term, investors should also focus on the long-term secular trends playing out across Asia, such as huge consumer markets, technology and green energy. The region also has favourable population demographics. These themes are creating opportunities in areas such as digitalisation, healthcare and wealth management.
Income and growth
Unlike in some Western markets, dividend investing in Asia does not necessarily come at the expense of growth. Many Asian companies pay stable dividends while also growing at a decent pace. Equally, income investors are not confined to low growth sectors. For example, the Abrdn Asian Income Fund has a high weighting in information technology stocks, focusing on areas such as hardware, semiconductors and foundry companies. The trust holds companies with strong balance sheets that are also growing their revenues and dividend payouts over time.
In Asia, dividend contribution has been on a steady upward path, helped by greater capital discipline and shareholder-friendly reforms. It now comprises close to half of total returns to shareholders. 2022 was a bumper year for dividends globally, but particularly so in Asia. The MSCI AC Asia Pacific ex Japan Index had a dividend payout ratio of 45% and a gross aggregate dividend yield of 3.4% as of end-December 2022, trumping most other major global markets on both metrics. On the trust, we increased the dividend by 7.5%, a 14th year-on-year increase, giving investors a significant head-start in outpacing inflation.
Valuations remain reasonable across Asian markets, while earnings have been at cyclical lows and look set to recover. There is still abundant choice of businesses that generate good profitability and cash flow and pay higher than the benchmark dividend. At the same time, their strong balance sheets should provide some defensiveness if the reopening trade proves bumpier than expected.
Portfolio in action
This balance of leaning into the recovery while managing potential risks is in evidence throughout the portfolio. The trust holds an overweight to Singapore, for example, because it provides a quality screen in accessing growth in markets such as Malaysia, Indonesia, Thailand and even China. The big banks in Singapore, such as OCBC, have exposure to China’s burgeoning small and medium-sized enterprises (SME) sector. The consumer-oriented and tech-linked names that we hold are hitched to secular themes, including e-commerce and technological development.
Our tech hardware and semiconductor holdings in TSMC and Samsung are the two largest positions for the trust. The dividend yield for both looks quite low, but these companies have grown their dividends per share on a dollar basis and follow a dividend pay-out policy that is linked to their free cash flow generation. Looking ahead, earnings growth for these market leaders looks well supported as prospects for high-power computing, data centres and servers remain compelling, while AI complexity would boost semiconductor demand and overall market expansion.
‘Going green’ is a strong theme across the portfolio, with significant government support for the renewable energy transition across Asia. Among the trust’s holdings here, electric vehicle (EV) battery manufacturer LG Chem has a cash generative chemicals business that provides funding for new investments and R&D in the energy storage space. LG Chem is now one of the top five EV battery players globally. PowerGrid – the national grid of India – is spending at least 20% of its capital expenditure on renewable energy sources, while also paying a compelling yield.
The opportunities from the reopening of China – and its impact across Asia – can be harnessed effectively through a dividend strategy, which may also provide greater protection against some of the risks. There is growth opportunity in income strategies in Asia and dividends have proved extremely resilient through the economic turbulence of recent years. Investors could be missing out if they focus only on growth strategies to participate in the region’s recovery.
Companies selected for illustrative purposes only to demonstrate the investment management style described herein, and not as an investment recommendation or indication of performance.
Risk factors you should consider prior to investing:
- The value of investments, and the income from them, can go down as well as up and investors may get back less than the amount invested.
- Past performance is not a guide to future results.
- Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
- The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
- The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
- The Company may charge expenses to capital which may erode the capital value of the investment.
- Movements in exchange rates will impact on both the level of income received and the capital value of your investment.
- There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
- As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
- The Company invests in emerging markets which tend to be more volatile than mature markets and the value of your investment could move sharply up or down.
- Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.
- Derivatives may be used, subject to restrictions set out for the Company, in order to manage risk and generate income. The market in derivatives can be volatile and there is a higher than average risk of loss.
Other important information:
Issued by abrdn Capital International Limited, registered in Jersey (38918) at 1st Floor, Sir Walter Raleigh House, 48-50 Esplanade, St Helier, Jersey JE2 3QB. abrdn Capital International Limited is regulated by the Jersey Financial Services Commission under the Financial Services (Jersey) Law 1998 (as amended) for the conduct of investment business and fund services business. abrdn Asia Limited, registered in the Republic of Singapore, Registration Number 199105448E.
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1 CLSA, Factset, 31 December 2022
2 Bloomberg, 8 March 2023