Emerging markets pay dividends, says ING IM’s Manu Vandenbulck
Manu Vandenbulck, senior investment manager at ING Investment Management, says income seekers should be looking to emerging markets.
Until recently, emerging markets (EM) equities did not figure in an income seeker’s horizon. After all, companies in the developing world have generally preferred to use profits to grow the business rather than distribute them to shareholders. This has led to the perception that emerging market investments offer share price gains but little income.
However, following the Asia crisis and several other crises in the 1990’s, companies in the emerging world realised that alignment with shareholders is crucial and began to embrace a dividend culture, prioritizing good cash flow and prudent balance sheets.
In 2012, emerging market companies paid out approximately 35% of retained earnings as dividends, a third above 2000 levels. The low figure is positive for dividend cover and hence dividend stability over time. The sustainability of dividend payments is further supported by healthy balance sheets that, on average, have lower leverage than companies in developed markets. While dividends tend to be higher in Europe, emerging market equities are offering investors, in addition to diversification benefits, dividend growth potential supported by low levels of company debt and higher profitability.
Emerging market companies have become more investible as their commitment to dividends increases shareholder alignment and accountability. The number of emerging market companies paying dividends has significantly increased over the last 10 years. Today, more than 600 stocks in global emerging markets offer a dividend yield of more than 2% and are sufficiently liquid for institutional investors. The weight of emerging markets in global equity markets (now around 13%) is expected to rise steadily in the coming years.
However, when looking for sustainable dividends in emerging markets, experience is crucial. The dividend policy of many companies in emerging markets is often based on a pay-out ratio of profits and, as such, dividend volatility will be as high as earnings volatility. In countries such as Brazil and Taiwan companies are obliged by law to pay out a certain percentage of profits in dividends. This increases the investable universe of dividend stocks in emerging markets, but does not necessarily mean that these dividends are sustainable. In Taiwan for example, many stocks are quite cyclical and sensitive to global demand , therefore earnings and dividends can be very volatile.
Yet, there are many emerging market companies that do not have the discipline or corporate governance that a dividend investor looks for. Healthy companies with a progressive dividend policy can only be identified after thorough fundamental research. Understanding political and other local risks present in emerging markets is also important.
In our stock selection we don’t exclude state owned companies as many governments are keen to access the recurring cash flows generated by these companies. In India for example, the government has asked state run companies to raise dividends. Funds are often needed by political parties to meet policy obligations and dividends can be used for this. Minority shareholders also benefit from a stronger push from governments on corporate dividend policy. This has contributed to strong performances of shares of many state-owned companies.