LONDON (Reuters) - 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 U.S. Treasury yields have collapsed to near-zero but world stocks still carry dividend yields of around 3 percent.
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 percent of retained earnings as dividends, Thomson Reuters data shows. That is a third above 2000 levels and in South Africa or Taiwan, payout ratios will be as high as 45-50 percent.
This has pushed emerging dividend yields - the ratio of dividends to the share price - to 2.6 percent, just below the developed market average. In some markets it is a lot higher.
“People are realizing 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.
GRAPHIC on dividend yields link.reuters.com/nem96s
GRAPHIC on payout ratios link.reuters.com/pyh96s
Investors have always played the emerging markets income story to some extent, but they have done so via U.S- and Europe-listed companies. Consumer goods giant Procter & Gamble (PG.N) 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 percent 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 percent in the five years to February 2012. The broader S&P EM index returned 22 percent.
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 (GAZP.MM) last year stunned investors by announcing it would double dividends to record highs while slashing capital expenditure by 40 percent. The main beneficiary was the state which owns over half of Gazprom.
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 privatization 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 are dividends - a trend already visible in Poland and Russia,” Renaissance Asset Managers said in a note.
“With future privatizations planned, sustained or improving dividends are likely.”
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 (TATA.NS) and Brazil’s Petrobras PCH.MZA are examples that are traded and held globally rather than by specialist emerging market investors.
“There is a realization that many emerging markets are not so emerging anymore,” 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,” says 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 percent 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 added.
Graphics by Scott Barber. Editing by Jeremy Gaunt.