Consolidate and hold the line
Alex Frew McMillan
Investors in Hong Kong are known for chasing growth stocks and only calculating their capital gains. When the market's hot, they buy in droves. But what do they do when just about all the world's main indexes are in the red? The Hang Seng Index is down 15 per cent for the year and global equities seem to lurch from crisis to crisis on a weekly basis.
Just in the past week, the Dow Jones Industrial average dropped 5.6 per cent the previous Monday and the Hang Seng slumped 7.7 per cent last Monday to Tuesday.
For those who are too nervous to plough into growth stocks but would like to put their money to work in some fashion, there is a third way: dividend stocks. These are equities that yield upwards of 5 per cent via dividend payouts. Because firms typically commit to paying out a fixed amount per share, the dividend yield improves as their prices fall - on an income basis, heavily sold dividend stocks represent excellent value.
Focusing on dividends also lets investors relax a little about the daily gyrations of a given share price. The stock may move up, it may move down, but an investor should have good visibility and comfort about the end-of-year dividend - and this yield should beat inflation and the returns offered on any guaranteed income fund.
Growth stocks are those shares that generate most of their gains in the form of share price increases. Hong Kong investors have traditionally preferred growth stocks because they are more likely to produce spectacular short-term gains. The returns on dividend stocks are boring by comparison. But in an environment where growth stocks are looking, at best, volatile and, at worst, like irredeemable money losers, safe but dull dividend stocks start to appeal.
A Credit Suisse report that looks at the total returns of Asian stocks over the past 15 years shows that dividends account for almost 40 per cent of their gains.
The study finds further that, in that 15-year period, a model portfolio of Asian dividend stocks returned an impressive 14 per cent annually. That was double the overall 7 per cent annual return for the MSCI Asia Pacific index in that period.
'While not able to offset the staggering declines in share prices, dividends are always positive and continue to lift returns,' the Credit Suisse study states.
The yield on equities is often greater than that paid by the same issuer on outstanding long-dated bonds. For example, National Australia Bank pays a net dividend yield of 7.53 per cent, while a March 2018 Australian dollar bond from the same entity yields 6.52 per cent, according to Bloomberg. Industrial & Commercial Bank of China shares pay a 4.44 per cent dividend while a yuan bond due July 2019 yields 3.28 per cent, according to Bloomberg.
Venerable HSBC pays out a 4.33 per cent dividend yield - investors would be hard-pressed to find that return on any HSBC debt.
'We suggest, when the market settles down, to identify blue chip stocks paying higher dividends as a first investment call, as opposed to riskier small to mid-cap stocks,' says Todd James, head of wealth management services for north Asia at BSI Bank. 'People should be looking at basic, dividend-paying stocks.'
The added bonus is that, should the world snap out of the crisis and stocks go on a big rally, dividend stocks will share that upside. They offer an option on equity growth that other income securities, such as bonds, do not.
Of course, equity income is attractive in its own right. Since 1995, dividends have accounted for a high share of equities' total returns in Asia - 38 per cent, according to the Credit Suisse report, which projects this figure could soon rise to 50 per cent, with more Asian stocks starting to pay dividends.
'Yield is starting to come back into fashion because of the volatility in the markets,' says Jahanzeb Naseer, Asian quantitative strategist at Credit Suisse and main author of the report. 'Over the next few months, money is going to come back into these stocks.'
The local bias towards growth is driven largely by the fact that most of the shares listed on the Hong Kong bourse are juggernaut stocks tied to the high gross domestic product growth of the mainland economy. These stocks tend to pay little or no dividends. They reinvest to fund more growth. Investors have largely applauded the strategy and have hung on for a share-price rise.
The city's lacklustre response to real estate trusts - an income security - has shown Hong Kong's deeply ingrained preference for growth over yield. The prevailing (and vaguely condescending) ethos seems to have been: if you want yield, you can go to Singapore, where most of the reits are listed.
'Investors in Hong Kong and Asia are generally much more aggressive in their view on capital gains and growth,' says Peter Kende, the founder of Hong Kong-based wealth management company Financial Partners. 'They will go for growth and be hands on, much like in the property market. When things go the wrong way they'll dump it.'
But he thinks that's a mistake. 'We are looking for value buying, not growth buying,' he says. 'In this cycle we really should be looking for equities that are going to deliver reasonable growth but, more importantly, will have their dividends stand up.'
Like any investing approach, buying dividend stocks involves a strategy. James of BSI recommends investors be mindful of the tax implications of buying overseas shares (often there is a withholding tax on dividends) and to take a good look at a stock's dividend history. A number can be skewed by a large recent dividend payout that will not be repeated.
He also recommends buying stocks that pay out a consistent yield year to year, and which are of a decent quality. 'This may sound a bit boring but this is what I would recommend for my closest family to do right now,' he says.
Credit Suisse recommends a dividend strategy weighted towards firms with a low-payout ratio.
The payout ratio is the percentage of profit that a firm pays out to investors in dividends. While it is good if a firm pays high dividends, it is even better if it retains a decent portion of its profits to fund growth (that is, it has a low to moderate payout).
Across Asia, Credit Suisse recommends high-dividend, low-payout ratio stocks. It says these stocks produce greater annual returns than high yield, high-payout stocks (14 per cent versus 11.2 per cent, according to its survey of the 15-year performance of Asian shares).
In the bottom rung were shares with low dividends and a high payout, which generated annual returns of just 5.2 per cent, according to the report.
Hong Kong is the exception to that rule. The dividend stocks listed here that bring the best returns tend to also pay out a high ratio of their profits to shareholders.
'This could be the reflection of a relatively mature market,' Naseer says. 'The companies with the biggest dividends in Hong Kong tend to be in industries that are quite mature, such as banks and utilities. If the bank is just going to sit on their balance sheets, I would prefer to get the cash.'
Credit Suisse's ideal dividend portfolio for Hong Kong consists of high-yield, high-payout stocks, such as Hang Seng Bank, The Link Reit, BOC Hong Kong, Power Assets Holdings, CLP Holdings, China Unicom, China Mobile, Hutchison Whampoa, Swire Pacific, Hong Kong Exchanges and Clearing, and CNOOC.
Certain securities, such as reits, are designed to produce decent income. The Link Reit yields a little over 4 per cent. But some lesser-known reits produce even greater yield - Fortune Reit yields above 10 per cent.
'I think the current environment sets up very well for reits,' says Peter Zabierek, the senior portfolio manager of global real estate securities at Udang, BNY Mellon's property-investment arm. 'It's clear there is a little more nervousness for investors. I think it sets up pretty well for yielding stocks.'
There are a multitude of income funds, including exchange-traded funds, that produce decent yields. Of the 76 ETFs listed in Hong Kong, the Polaris Taiwan Top 50 Tracker Fund generates the highest dividend yield, at 4.4 per cent per year.
The quest for yield 'has been going for months', says Marco Montanari, head of the db X-tracker ETF business in Asia. 'Fixed-income yields have been very low, generally speaking, interest rates have been very low and, generally speaking, high-dividend stocks are higher-value stocks. They tend to outperform the market when the market is flat or not leading a very bullish period.'
The db X-trackers FTSE Vietnam Index ETF has the second-highest dividend of all Hong Kong-listed ETFs, at 4.2 per cent.
There are eight ETFs available in Hong Kong that pay yields of more than 3 per cent, including the Lyxor ETF FTSE RAFI Europe, other Taiwan ETFs and the Deutsche Bank ETF devoted to Brazil.
Deutsche Bank has also developed an ETF devoted to the chase for cash payouts, the db X-trackers MSCI Asia ex-Japan High Dividend Yield. The product launched in Singapore in April. It is not available in Hong Kong.
Looking at Asian stocks in general, it's clear a high-dividend approach pays off. The MSCI Asia ex-Japan High Dividend Yield index has outperformed the MSCI Asia ex-Japan index by an average of 4.4 per cent per year since 2000, through the end of July.
Specifically, the MSCI Asia ex-Japan High Dividend Yield index has produced an average annual return of 16.9 per cent, compared with just 12.5 per cent for the broader MSCI Asia ex-Japan index.
Naseer suggests a high-dividend approach is worth pursuing even in up markets. But high-yield stocks generally show their greatest outperformance when overall markets are performing badly. And that's the situation investors are facing now.
'Value stocks and high-dividend stocks may not have the same performance as growth stocks when the markets are really bullish - but I don't think investors have that feeling now,' Montanari says.