Defensive returns: the Asian equity income opportunity

This article was originally published by Fidelity International on 2 June 2023. Please refer to the original article for additional disclaimers.

From a portfolio perspective, it’s generally accepted that diversification involves maintaining a core blend of stocks and bonds. Holdings that will perform well at different stages of the economic cycle to help minimise risk and deliver consistent returns.

Investors generally think of this core mix as serving two principal functions: stocks for capital growth and bonds for income. In fact, stocks can be a powerful source of income, too. And in the current climate, investors looking to add income to their portfolios may want to consider Asian equities.

The route to equity income

The primary vehicle for generating income through equities will be a dividend fund. The job of a dividend fund is to deliver attractive risk-adjusted total returns over an extended period, in which dividends form a vital part of those returns.

At Fidelity, our dividend fund managers typically adopt a bottom-up stock-picking approach, deploying large teams of analysts on the ground in Asia to meet and assess companies.

The businesses they choose to invest in have specific characteristics. For example, they must have strong operational models that enable them to generate resilient “through-cycle” returns (meaning they can deliver in both rising and falling markets). They also tend to have conservatively managed balance sheets, good cash generation, sound governance frameworks, and management teams with a solid record of capital allocation in which dividends are a priority.

Since dividend funds are also firmly focused on downside mitigation, managers are highly conscious of value and select high-quality stocks only if the valuation is attractive.

Asia – underpinned by two vital factors

The Asian market is increasingly relevant and important for equity income investors. Twin factors make the region an appealing destination: attractive headline yields and good prospects for dividend growth over time.

On the one hand, there are markets such as Australia or Taiwan that are more mature in nature and offer certain tax advantages or incentives for companies to pay higher dividends.

On the other hand, there are emerging territories where pay-out ratios are still relatively low but should see higher dividend growth over time.

Furthermore, in some markets, governments are encouraging companies to return more cash to shareholders, notably in China, where the government is eager to improve the investment appeal of state-owned enterprises.

Key areas of the market to watch

The investment environment in Asia currently favours some specific sectors for dividend income.

China – The economy has rapidly reopened, propelled by monetary easing, fiscal policy, and a supportive regulatory backdrop. Crucially, China is not seeing the inflationary pressures hampering the West that are slowing the consumer and corporate environment.

Opportunities in China include firms that will benefit from the country’s reopening, both domestically and in the wider region, such as through rebounding tourism.

Technology – The pandemic-fuelled technology surge has faded over the past 12 months. Inventory levels have started to decrease, and valuations for many hardware technology names, which are industry leaders in Asia, now look attractive.

For example, the computer memory sector has consolidated over time. That makes for a much more rational market than before. As a result of the post-COVID weakness in demand and depressed profitability, the remaining key players have started to reduce capacity – the last step required for a cyclical recovery.

Banks – The challenges faced by some US and European banks had only a limited impact on Asian lenders, mainly because most of the region’s banks have strong capital positions, are subject to robust regulations, and in most cases, have large and resilient deposits.

Non-bank financials – Leasing companies, exchanges, and selected insurers tend to operate in market niches with less competition and more growth potential than banks and generate relatively attractive returns on capital.

Broadly speaking, corporate dividend announcements in Asia have been in line with, or slightly better than, expectations. This reflects the improving fundamentals, propelled by China’s reopening, which in turn is boosting the confidence of corporate management teams. Some major companies have also initiated large share buyback schemes and announced dividend increases.

Asia is often associated with high growth and elevated risk. However, with strategic allocation, Asian stocks present an often-overlooked income opportunity.

Explore Dividend Funds with Fidelity

You can access over 200+ Best-In-Class funds on Endowus Fund Smart curated by the Endowus Investment Office using our proprietary SMART+ fund selection framework. Explore dividend funds from Fidelity below:

• Fidelity Global Dividend Fund (ISIN: LU0742537680)
• Fidelity Asian Pacific Dividend Fund (ISIN: LU1119993845)

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