As a consequence, emerging markets have delivered the fastest dividend growth of any region over the past decade or so.
There are two basic statistics that often surprise. First, the dividend yield on emerging markets equities is already comparable with that of developed markets, and is well above the yield delivered by either the US or Japan.
Secondly, a higher proportion of emerging markets companies pay dividends than their DM counterparts. This is important because it allows us to build a portfolio that is well diversified across countries and sectors, and does not force a concentration in particular areas such as utilities and telecoms that are more traditionally associated with high dividends.
The case for dividend investing in emerging markets is growing ever stronger. However, it is a strategy that has already proved its worth. Dividends represent a significant proportion of emerging markets total returns. Simple back-tests show that higher yielding stocks in the EM universe have outperformed lower yielding stocks over many years.
While value investing styles overlap with dividend styles rather than being interchangeable with them, similar results can be seen from analysis of ‘value’ versus ‘growth’ in emerging markets.
In a region that can be prone to large swings in both fundamentals and sentiment, a focus on dividends has a smoothing effect on volatility, offering welcome downside protection for EM investors.
While a reliance just on dividends is no substitute for in-depth research on potential investments, the fact that a company has got to the stage of maturity where it is able to return real cash to shareholders means that it is less likely to collapse overnight, or in a worst case actually be fraudulent. It is perhaps not a coincidence that Sino-Forest never paid a dividend.
In common with dividend investing in developed markets, I believe that a fundamental and research-led approach is essential. Simply selecting the highest dividend yields is unlikely to produce an outperforming portfolio as high yields are often a signal that the current dividend is unsustainable.
Evidence suggests the best-performing EM stocks tend to be those with moderate yields of 3 per cent to 4 per cent – in other words healthy companies generating solid cash flows, returning a proportion to shareholders while re-investing the rest in future growth.
It is not an easy task to identify these companies while insisting that they also meet the criteria of being attractively valued, and it is this painstaking process of research and analysis that occupies the majority of our time as portfolio managers and equity analysts.
In a region often perceived to be largely about ‘top-down’ investment styles, more than half the long-run returns from emerging markets can be explained by company-specific, rather than macro, factors.
With hindsight, the success to date of EM dividend strategies may be partly explained by investors’ search for yield in a low-interest rate world. Indeed, prior to Ben Bernanke’s speech in May this year, where the idea of ‘tapering’ QE was first introduced, there were even concerns of a bubble developing in EM dividend stocks.
