London - Global investors in search of high dividend equity
plays are heading to emerging markets, abandoning their view of these stocks as
a predominantly growth-based investment.
It marks another milestone in the sector's global coming of
age.
The trend is part of a broader shift that is recasting
equities as yield-bearing, income-providing assets - natural at a time when US
Treasury yields have collapsed to near zero but world stocks still carry
dividend yields of around 3%.
Emerging equities were not until recently part of income
seekers' horizon as companies in the developing world have generally preferred
to use profits to grow the business rather than give them to shareholders.
Hence the perception that EM investments will offer share price gains but
little income.
But a flurry of fund launches over the past year testify to
a distinct shift, not just in investor attitudes but also in emerging
companies' dividend policies.
This year, emerging companies will pay 35% of retained
earnings as dividends, Thomson Reuters data show. That is a third above 2000
levels and in South Africa or Taiwan, payout ratios will be as high as 45-50%.
This has pushed emerging dividend yields - the ratio of
dividends to the share price - to 2.6%, just below the developed market
average. In some markets it is a lot higher.
"People are realising you can actually get decent
income in emerging markets, an area you didn't normally associate with
income," said Julian Mayo, who manages an equity income fund at specialist
emerging markets investor Charlemagne Capital.
Investors have always played the emerging markets income
story to some extent, but they have done so via US- and Europe-listed
companies. Consumer goods giant Procter & Gamble, for instance, derives most
of its profits from emerging markets and has raised dividends every year for
the past 50 years.
But a big catalyst in the push to diversify income streams
was BP's 2010 oil spill disaster, which hit shares and dividend payouts to UK
pension funds and highlighted the risks of depending too heavily on a single
market for income.
There is another worry - the slowdown in Western growth and
consumer spending, and the focus in many sectors on cutting debt.
Profits and cashpiles at S&P 500 companies are at record
highs at the moment, but in an ominous sign payout ratios have fallen to
all-time lows, possibly reflecting managers' doubts over future earnings
growth. Most companies see dividends as a longer-term commitment, raised or cut
according to the outlook.
In this environment, emerging markets are at an advantage,
fund managers argue, citing the companies' improved capital discipline and
better understanding of the need to keep shareholders sweet via regular cash
payouts.
Ironically, what was not so long ago seen as a drawback -
currency exposure - is now considered a plus.
In recent years, dividend receipts in the Indonesian rupiah
or Brazilian real would have been what David Baran, a fund manager at Symphony
Financial Partners, dubs a "slam-dunk" trade, one providing share
price and currency gains plus income.
"If you are capable of managing a multi-currency
dividend stream, either via hedging or not, you can pick up a 4.5% dividend
yield plus you get it in a currency that's rising, so what's not to like?"
Tokyo-based Baran said.
Dividend-paying stocks can fare better in the longer term
than other kinds of equities. A special S&P index of high dividend emerging
stocks returned 35% in the five years to February 2012. The broader S&P EM
index returned 22%.
Government policy
Recent higher dividends may also have been motivated by
governments' eagerness to raid the cash hoards of state-run firms which make up
a major part of emerging stock indices.
Russia's largest company Gazprom last year stunned investors
by announcing it would double dividends to record highs while slashing capital
expenditure by 40%. The main beneficiary was the state, which owns over half of
Gazprom.
Similarly in India, the government has asked big state-run
companies such as ONGC and SAIL to raise dividends as it struggles to fill its
budget deficit.
Such state-run entities have tended to be worst dividend
payers, notorious for wasteful capital spending. Huge dividend increases at
governments' behest may also not be sustainable.
But many of these firms are also slated for privatisation
and are keen to present a more shareholder-friendly image.
"Governments, which remain significant shareholders in
many of the companies, need cash to meet social obligations, and the
increasingly preferred method for generating capital is dividends - a trend
already visible in Poland and Russia," Renaissance Asset Managers said in
a note.
"With future privatisations planned, sustained or
improving dividends are likely."
Maturing
In any case, shares from the biggest developing economies are
increasingly featuring in global portfolios that may not be content with just
capital growth. Gazprom, India's Tata and Brazil's Petrobras are examples that
are traded and held globally rather than by specialist emerging market
investors.
"There is a realisation that many emerging markets are
not so emerging any more," Symphony's Baran said. "To define
something as emerging markets and let them get away with not paying dividends
is so 1980s."
Greater focus on shareholders can of course be viewed as part
of the maturation process at emerging corporates, but it may also necessitate a
change in investor strategy.
"The emerging markets story is not over but it's
different. Supernormal returns that people got from EM in the past decade won't
be the case in coming years," said Edward Lam, who runs an EM income fund
at Somerset Capital Management in London.
Lam sees EM equity gains moderating in coming years towards
the 7-8% a year common in the developed world.
"That's a big shift which means the growth capital
returns won't be there to the same extent and if you want returns you will need
to look at what you can get out of income. Basically it is a coming of age of
emerging markets," he said.